What Is the 28% Rule for Home Affordability?

The 28% rule is a guideline in personal finance for determining an affordable monthly housing payment. The principle suggests that a household should dedicate no more than 28% of its gross monthly income toward housing costs. This guideline helps individuals avoid becoming “cost-burdened,” where high housing payments strain their ability to cover other living expenses or save for the future. By establishing a clear ceiling for housing expenditures, the rule aims to promote financial stability.

Calculating Your Front-End Ratio

The 28% rule is also known in lending circles as the front-end ratio. To calculate it, you divide your total proposed monthly housing costs by your gross monthly income. The total housing expense is often summarized by the acronym PITI: Principal, Interest, property Taxes, and homeowners’ Insurance.

The principal is the portion of the payment that reduces your loan balance, while interest is the cost of borrowing money. Property taxes are paid to local governments, and homeowners’ insurance protects the property against damages. Lenders also include other mandatory fees, such as homeowners association (HOA) dues or private mortgage insurance (PMI) for those with a down payment under 20%.

The denominator is your gross monthly income, which is your total earnings before taxes or deductions. To find the ratio, you divide the total monthly housing cost by your gross monthly income. For example, if your housing costs total $2,100 and your gross monthly income is $8,000, your front-end ratio would be 26.25% ($2,100 ÷ $8,000).

Understanding the Back-End Ratio

While the front-end ratio focuses on housing costs, lenders use the back-end ratio for a more comprehensive view of a borrower’s financial obligations. Also known as the debt-to-income (DTI) ratio, this metric considers the percentage of your gross monthly income used to cover all recurring monthly debt payments, including housing. A common guideline for the back-end ratio is that it should not exceed 36%.

The calculation starts with the same total housing payment from the front-end ratio. To this figure, you add all other monthly debt obligations that appear on a credit report. These include minimum credit card payments, auto loan payments, student loan payments, and any other personal loans.

The sum of your housing costs and other debts is then divided by your gross monthly income. For instance, if the borrower with an $8,000 monthly income has a $2,100 housing payment, a $400 car payment, and a $250 student loan payment, their total monthly debt is $2,750. Their back-end ratio would be 34.4% ($2,750 ÷ $8,000), which is within the 36% guideline.

How Lenders Apply These Ratios

The 28/36 rules are standard benchmarks for conventional loans that conform to guidelines set by Fannie Mae and Freddie Mac. These ratios are not inflexible laws but help lenders assess risk and a borrower’s ability to repay the loan. An applicant who fits within these percentages is viewed as a lower-risk borrower.

Different loan programs allow for more flexibility. Government-backed loans, for instance, often have higher allowable DTI limits. For Federal Housing Administration (FHA) loans, guidelines recommend a back-end ratio of no more than 43%, though lenders may approve a higher ratio with compensating factors. The Department of Veterans Affairs (VA) does not set a firm DTI limit, but lenders often look for a ratio of 41% or less.

Lenders can approve applicants who exceed the 28/36 guidelines if there are compensating factors. These are positive elements in a borrower’s financial profile that offset the higher risk of elevated DTI ratios. A high credit score, a large down payment, or significant cash reserves remaining after closing can all serve as compensating factors. For example, having enough savings to cover several months of mortgage payments can demonstrate financial stability.