If you’ve been thinking about buying a house, then you might have heard about some mystery rule called the 28/36 rule. But what is it and why should you care? Let’s find out…
What is the 28/36 Rule
The 28/36 rule is a guideline used in the financial world.
It can be used to determine how much of a mortgage payment someone can afford.
It is based on your gross monthly income, the total amount of your housing expenses, and the total amount of your debt payments.
The 28/36 rule lets you know how much you can afford for a house based on what you have leftover each month after all other obligations have been paid.
The 28/36 rule enables a bank to determine whether a client can afford a certain mortgage payment, or if they have overextended themselves.
For example, if you are looking to buy a new home and the mortgage payments will be $1,000 per month, your lender will use the 28/36 rule to determine whether or not you will be able to afford your monthly mortgage payment.
Let’s say you make $4,000 per month.
The bank will want your new mortgage payment to be 28 percent or less of your monthly income.
So, you will want to divide $1,000 by $4,000 dollars.
That will give you an income ratio (the first half of the 28/36 ratio) of 25 percent.
($1,000 / $4,000 = 0.25)
That’s good news. Your mortgage payment will only be 25 percent of your income.
Next, you need to take a look at your other debts.
Let’s say you have debts such as a student loan, credit cards, and a personal loan. Your monthly payment for all of your debt (not including your mortgage) is $500 dollars.
The bank will want to make sure that all of your debts including your mortgage payment (in this case a $1,000 dollars) do not add up to more than 36 percent of your income.
With your $4,000 dollar per month income, the total of all of your debts will be 37.5 percent of your income.
($1,500 / $4,000 = 0.37.5)
That means you are over the 36 percent threshold.
You might have difficulty getting the mortgage you want.
One option would be to pay off some debt before you apply for a mortgage, so you get down below the cut-off point.
Why is the 28/36 Rule Important?
The 28/36 rule can come in handy during the early planning stages of getting a mortgage loan.
There are many different factors that come into play when determining if an individual can afford a particular loan, including credit scores and length of employment.
Using the 28/36 rule helps to narrow down an affordable range for your actual loan payment so that you are not overwhelmed with more expensive choices.
It will give you an idea of how much house you can afford before you start shopping for one with a real estate agent and before you go to a lender to secure a mortgage.
If you want a bigger, more expensive house, you will know how much debt you will need to pay off before you try to buy one.
If you are comfortable with the price level you can afford, then you are good to go.
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What to do If You Have Too Much Debt to Get a Mortgage
One of the most common reasons why people don’t get approved for a mortgage is because of debt.
Excessive debt can keep you out of the running for a new home no matter how much money you are earning.
In order to get approved for a mortgage loan, your debt must fall within certain guidelines.
Most lenders will consider you if you have less than 36% of your take-home pay goes toward paying off monthly expenses and debts.
The higher the percentage, the greater chance that they will turn you down.
If this is true for your situation, there may still be options available to help you buy a house even with excessive payments.
Paying off debt is one way to increase your chances of being approved for a loan.
You’ll need to do this first before you approach a bank.
You can also save more for a larger downpayment.
If you do, you will be borrowing less which means your mortgage payments will be lower as well and will be a smaller percent of your income.
Why It’s Smart to Follow the 28/36 Percent Rule
Since you will need to make monthly payments for at least 30 years, it is very important that your payments do not consume too much of your salary.
If your house payment is too high and you have a lot of debt, it can be very easy to end up in a difficult financial situation.
If you lose your job or have an accident and can’t work for a while, you may not be able to pay your mortgage.
Then you’re looking at foreclosure and having nowhere to live.
No one wants that.
You will be in a much better position financially if you follow this rule. And you will be able to save more money over the years, so if something happens and you take a financial hit, you can cover it.
How to Fix a Poor Credit Score
A poor credit score can put a serious dent in your chances of getting a mortgage or even renting an apartment.
However, fixing your score doesn’t have to be impossible.
It just takes some time and discipline.
The following tips can help you get started repairing your credit scores right away.
1. Make Sure Your Payments are on Time
Missing payments is one of the easiest ways to ruin your credit score.
Always pay on time, every time.
Even if you’re late, call the company right away to let them know or pay it later that day if you can’t make it before they close that day.
2. Don’t Close Accounts
Another easy way to ruin your credit score is by closing accounts that are open.
Closing credit card accounts after paying them off will lower your overall credit score and make it difficult for others to see how responsible you are with your money.
If you close your credit card accounts after you have paid off the balance, then you will decrease the amount of available credit you have.
This will lower your overall credit score.
Save More for a Larger Downpayment
If you want to take out a larger mortgage, your best bet is to save more for a larger down payment.
A down payment of 20% or more will get you the best rates.
To save up for a down payment, open a savings account and instruct your employer to have your contributions direct deposited into the account.
If you can’t afford to save by payroll deduction, set up a separate savings account at the bank and transfer money into it each month.
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To Sum it All Up:
The 28/36 rule isn’t there to make your life more difficult. In fact, it will help you. Follow this rule and you won’t find yourself overextended years down the road. You can sleep easier knowing you have the money to pay your mortgage and other debts without worry or stress.