Mortgage lenders use two ratios, called debt-to-income ratios, among other requirements, to qualify you for a home loan. These ratios are known as the front-end ratio and the back-end ratio. The 28/36 rule designates the maximum percentages -- 28 percent and 36 percent -- your debt-to-income ratios can be to qualify for a typical conventional home loan.
The first part of the 28/36 rule requires your front-end ratio to be no more than 28 percent. The front-end ratio equals your monthly housing costs divided by your gross monthly income, which is what you earn before taxes. If you apply for a loan with a co-borrower, a lender includes both of your incomes. Monthly housing costs include the principal and interest portion of your mortgage payment and any money you deposit into escrow for mortgage insurance, hazard insurance and property taxes.
Front-End Ratio Calculation
Assume you make $5,000 in gross monthly income and want to qualify for a mortgage with a $1,000 monthly principal and interest payment. Also, assume you will pay $200 per month into an escrow account for mortgage insurance, hazard insurance and property taxes. Your total monthly housing costs would be $1,000 plus $200, which equals $1,200. Your front-end ratio would be $1,200 divided by $5,000, which equals 0.24, or 24 percent. Because this is less than 28 percent, you would meet the first part of the 28/36 rule.
The second part of the 28/36 rule requires your back-end ratio to be no more than 36 percent. The back-end ratio equals your monthly housing costs plus your other monthly debt payments, divided by your gross monthly income. Monthly debt payments include secured and unsecured debts, such as car loans, student loans, credit cards and child support. If you have a co-borrower, a lender includes both of your incomes and debt payments.
Back-End Ratio Calculation
Assume your monthly debt payments, excluding your housing costs, are $500. Assume the same gross monthly income and housing costs from the previous example. Your back-end ratio would be $1,200 plus $500, divided by $5,000, which equals 0.34, or 34 percent. This is less than the maximum 36 percent allowed by the 28/36 rule. Since you meet both debt-to-income ratios under the 28/36 rule, you would qualify for the loan provided you meet the lender’s other requirements.
If one or both ratios exceed the percentages allowed under the 28/36 rule, you would need to take action to bring the ratios within the limits. You might reduce the mortgage loan amount with a larger down payment or consider another type of loan with a smaller payment. If you fail to meet only the back-end ratio, you might pay down some of your debts to reduce your monthly non-housing debt payments.
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