What is the 28/36 Rule
The 28/36 Rule is the rule-of-thumb for calculating the amount of debt that can be taken on by an individual or household. The 28/36 Rule states that a household should spend a maximum of 28% of its gross monthly income on total housing expenses and no more than 36% on total debt service, including housing and other debt such as car loans. This rule is used by mortgage lenders and other creditors to assess borrowing capacity, the premise being that debt loads in excess of the 28/36 parameters would be difficult for an individual or household to service and may eventually lead to default.
BREAKING DOWN 28/36 Rule
The 28/36 Rule is important for individuals to be aware of when applying for all types of credit. The 28/36 Rule is a standard that is used by most lenders in addition to a borrower’s credit score. All of the data used to arrive at a credit decision is pulled by the underwriter from a borrower’s credit record on file with a partnering credit data agency.
An individual’s credit score is often a primary factor involved with the approval of a credit application. Lenders will require that a credit score fall within a certain range. However, the credit score is not the only consideration for approval. Lenders also consider a borrower’s income and debt to income ratios. The 28/36 Rule is a guide that lenders use to structure their underwriting requirements. Some lenders may vary these parameters based on a borrower’s credit score, potentially allowing high credit score borrowers to have slightly higher debt to income ratios.
28/36 Rule Parameters
Lenders using the 28/36 Rule in their credit assessment may include questions about housing expenses and comprehensive debt accounts in their credit application. Each lender establishes their own parameters for housing debt and total debt as a part of their underwriting program.
Most traditional lenders will require a maximum household expense to income ratio of 28% and a maximum total debt to income ratio of 36% for loan approval. This means that household expense payments, primarily rent or mortgage payments, can be no more than 28% of monthly or annual income. Similarly total debt payments cannot exceed 36% of income. Many underwriters vary their parameters around the 28/36 Rule with some underwriters requiring a lower percentage and some requiring a higher percentage.
Some consumers may use the 28/36 Rule as a consideration when planning their monthly budget. While they may not currently be seeking additional credit, these parameters can help to improve their chances of credit approval. For example, an individual with a monthly income of $5,000 who seeks to adhere to the 28/36 Rule could budget $1,000 for a monthly mortgage payment and housing expenses. This would leave them with an additional $800 for making other types of loan repayments.