The 28/36 Rule Explained: How to Budget Using the 28/36 Rule

The 28/36 rule is a personal finance principle that caps how much of a person's gross monthly income should go to housing costs and how much should go to monthly debt payments. There are two core tenets of the 28/36 rule.

• No more than 28 percent of your gross monthly income should go to monthly housing costs. This goes beyond a monthly mortgage payment to include all costs related to holding title on a home. Sometimes the ratio of housing expenses to your total income is called the PITI ratio, where PITI stands for principal, interest, taxes, and insurance.
• No more than 36 percent of your gross monthly income should be spent on total debt and loan payments. This total monthly debt includes conventional mortgages, but it also includes other forms of borrowing like credit card debt and personal loans.

The 28/36 rule is applied to financial decisions regarding budgeting and taking on new debt. First-time homebuyers and other types of borrowers sometimes break down the 28/36 rule into two types of ratios: a front-end ratio and a back-end ratio.

• Front-end ratio: The front-end ratio of the 28/36 rule is a ratio of your total housing expenses to your total income before taxes. According to the rule, that ratio should not be greater than 28/100. For most homeowners, the primary contributor to housing costs is their monthly mortgage payment, but housing costs also include homeowners insurance, property taxes, and homeowners association (HOA) dues. They do not include one-time costs at the time of purchase such as closing costs, a credit report, and one-time mortgage insurance. They also do not include everyday household expenses you must pay regardless of homeownership, such as groceries and utilities. Your front-end ratio will vary depending on the size of your down payment, the size of your mortgage loan, your credit score, and prevailing interest rates charged by mortgage lenders.
• Back-end ratio: The back-end ratio of the 28/36 rule is a ratio of your total debt expenses to your total income. According to the rule, the debt-to-income ratio (DTI ratio) should not be greater than 36/100. For most homeowners, a home loan represents the largest share of their monthly debt. However, many other factors can contribute to your back-end ratio including credit card debt, student loans, car loans, VA loans, personal loans, alimony payments, and child support.

Imagine you have an annual income of $48,000 based on a W2 employee salary and extra cash from some odd jobs. This breaks down to a monthly pre-tax income of $4,000. With this in mind, you would have the following limits for your monthly real estate expenses and debt expenses.

• A maximum of $1,120 per month on housing expenses: Twenty-eight percent of $4,000 is $1,120. To stay within the 28/36 rule, you would have to spend no more than that amount on mortgage payments, property taxes, HOA fees, and related costs.
• A maximum of $1,440 on all debt payments: Thirty-six percent of $4,000 is $1,440. To stay within the 28/36 rule, you would have to spend no more than that amount on homeownership, credit card interest, and various forms of loans.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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