Mortgage lenders use qualification ratios to determine the amount they will lend to borrowers. While ratios may vary slightly among lenders, they generally fall within the same range. To help determine an individual’s qualifications, mortgage lenders typically use the following three ratios.
Rule of 28: Your maximum mortgage payment should not exceed 28% of your gross monthly income (pre-tax income). For instance, if you and your spouse earn a combined annual income of $120,000, your monthly mortgage payment should not exceed $2,800.
Rule of 32: Your total housing costs, including mortgage, insurance, association fees, and property taxes, should not exceed 32% of your gross monthly income. Using the previous example, the couple’s total housing costs should not exceed $3,200 per month.
Rule of 40: Your total debt payments, including housing, auto, student loans, and credit cards, should not exceed 40% of your gross monthly income. In the example, if the couple earned $120,000 per year, their total debt payments, including housing, could not exceed $4,000 per month. This would leave a maximum of $800 per month for other recurring debt such as auto, student loans, and credit cards. This rule emphasizes that if you have significant debt, such as car payments or credit card balances, it will limit the amount you can afford for mortgage payments. In many cases, banks require reducing or eliminating some or all other debt before approving a mortgage.
By following these rules, you can determine a reasonable budget for your home purchase based on your income and financial obligations.
