The 28/36 Rule: How It Affects Your Mortgage Approval

Want to buy a home? If so, you should know the golden rule of mortgage lending. The 28/36 rule measures borrowers' ability to afford their mortgages based on their households' gross monthly income, monthly housing-related payments, and all other monthly debt payments.

The 28/36 rule states that a household should spend no more than 28% of its gross monthly income on total housing expenses, and no more than 36% on all debt, including housing-related expenses and other recurring debt service.

The details of the 28% front-end ratio

Let's start with the first half of the rule, which is that a household should spend no more than 28% of its gross monthly income on housing expenses. This is called the "front-end ratio."

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Housing expenses are generally summarized as PITI: monthly principal, interest, property taxes, and insurance payments. They also include any housing association or condo fees. The front-end ratio does not include other housing expenses like utility bills or cable TV services.

If a borrower expects to pay $1,100 in monthly principal and interest, plus $300 in property taxes and homeowners insurance payments, the PITI costs would be $1,400 per month. Thus, the household must have gross monthly income (pre-tax income) of at least $5,000 per month ($1,400 / $5,000 = 28%) to qualify on the front-end ratio.

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Smart applicants can qualify for a mortgage without kissing their savings goodbye. Image source: Getty Images.

The fine print on the 36% back-end ratio

The second half of the rule is the back-end ratio. This ratio is calculated by dividing all recurring monthly payments on debt by a household's gross monthly income. The back-end ratio includes all debt: PITI payments on your mortgage, any homeowners-association dues or condo fees, and credit cards, car loans, student loans, and other personal loans. Where applicable, the back-end ratio also includes required monthly child support or alimony payments. A past divorce can come back to haunt a borrower when it comes time to apply for a mortgage.

There is an important detail you should know: Monthly payments are only included in the back-end ratio when they are expected to be paid for the next 10 months or more. For example: A car loan with 12 remaining monthly payments would be included, but a car loan with only nine payments remaining would not be. Paying down your other loans can be a really good way to qualify for a larger mortgage.

The borrower with $1,400 in PITI payments might also have a $200 monthly car payment, and a $250 student loan payment; back-end monthly debt payments would tally to $1,850 per month. To qualify under the back-end ratio, this borrower would need to earn at least $5,139 ($1,850 / 0.36 = $5,138.88) in gross monthly income.

How to qualify for a larger mortgage

Conventional mortgage underwriting tends to have the most stringent requirements. Buying a home with an FHA (Federal Housing Administration) mortgage generally requires a household to qualify under a 31/43 rule, but this rule can be further relaxed in specific scenarios. Energy-efficient homes can qualify under an expanded 33/45 rule when financed through the FHA, which is much easier to meet than the standard 28/36 rule for conventional loans.

Sources: Federal Housing Administration, conventional lenders.

Although some lenders are willing to stretch on terms, these loans are riskier for the borrower and lender alike. Borrowers who can qualify under the 28/36 rule shouldn't have much difficulty repaying their loans. Stretching too far may make it difficult for homeowners to pay their loans on time, or in full. Homeownership may be the American dream, but anyone who has lost a home to foreclosure will tell you it is an American nightmare.

There are three ways to safely increase the amount you can borrow:

1. Earn more: While earning more isn't as easy as pressing a button, it will enable you to buy a more expensive home. A borrower who can reasonably expect to earn more in the near future (a nurse who will soon become a nurse practitioner, for example) might thus qualify for a larger mortgage thanks to a higher income.
2. Pay down debt: Paying down debt helps your back-end ratio by leaps and bounds. Debt with the highest monthly payments as a percentage of the principal balance (car loans and credit cards, for example) should be prioritized. Consider applying for a mortgage once you have fewer than 10 months of payments remaining on a car or student loan.
3. Make a larger down payment: How much you borrow has a greater impact on your front- and back-end ratios than how much the home costs. Waiting a year to save more will help you qualify for a larger mortgage.

Of these three methods, the best way to qualify for a mortgage on a more expensive home is to pay down your existing debt.Consider this: A borrower with a $300 monthly car payment would need to earn $833 more than a borrower who does not have a car payment in order to qualify for the exact same mortgage amount. It seems silly -- $833 in pre-tax income easily covers a $300 car payment, and then some -- but it's an illustration of just how punishing the math of mortgage underwriting can be to indebted borrowers.

The bottom line: The best way to qualify for a mortgage is to follow the basics of good personal finance: Save more, spend less, and pay off your consumer debt before applying. People who do these three things should sail through the underwriting process and get a mortgage on affordable terms.

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