What Is The Percentile Rule For Buying A House?

Buying a home is complicated. It's a lot more than just offering up some money and getting the keys. Most people have to get a mortgage, which can be a convoluted process thanks to lending guidelines that the average potential homeowner may not understand. For example, you probably know your debts and credit history can affect your chances of getting a loan, but did you know there's a percentile rule that many banks use as a gauge? It is known as the 28/36 rule, and it's one way financiers determine not only whether you can get a loan, but also how much it should be.

The first half of the rule suggests that your monthly housing payments shouldn't go above 28% of your gross, or pre-tax, monthly income. This number is based on some of the most important factors to identify before buying a home, including your mortgage payment, interest, HOA fees, property taxes, and insurance. 

The second half of the rule applies to your total monthly debt payments, which shouldn't exceed 36% of that same income. This can include things like credit cards, student loans, car loans, and medical bills, in addition to your mortgage. Banks look at both of these numbers before making a final decision. If it goes beyond that, you may need to look for a property with a lower monthly payment or pay off a few debts.

Numbers are neat, but sometimes they're hard to conceptualize. Let's look at an example. Say your household earns about $70,000 a year before taxes. Using this number, your monthly income works out to roughly $5,833. Therefore, your house payments shouldn't exceed $1,633, while your total monthly debt payments would be about $2,100 or less.

There's a reason these are the numbers banks suggest.  Keeping debt at a manageable level can make it easier for you to pay off everything on time and even handle some unexpected expenses. For example, if your truck suddenly needs new tires, you can likely still afford the replacement and cover your obligations. However, if you go above the percentile rule, you have less flexibility for a rainy day.

Debt-to-income ratio isn't the only thing lenders consider, though. If you have a history of reliable repayments and a good credit score, they're more likely to let you go a little above 28% when you apply for a loan. You can also look at the amount you are putting down and how it will affect your mortgage. While you don't need a 20% down payment to buy a house anymore, the lower you go, the higher your monthly mortgage payment will be.

While many lenders use the 28/36 rule, it may not be ideal for every situation. It has some blind spots, including expenses like transportation, daycare, and costs that aren't consistent every month. Plus, it doesn't leave you with much wiggle room. If 28% of your income is already dedicated to the house payments, keeping total debt at 36% only leaves 8% for all other debts. Large purchases are pretty much out of the question for potentially 30 years.

The rule isn't always practical, either. Because of increasing natural disasters, some states with regular hurricanes, fires, or tornadoes have high insurance costs that can push an affordable house past the 28% threshold. Plus, it doesn't account for rising property taxes, utilities, or repairs that can take another bite out of your budget. Getting a home at the maximum range of what you can afford also means that if you lose your job or get injured, you may be left floundering.

However, you can use the 28/36 guideline to your advantage. If you really want to make sure you get approved for a home loan, it's a good idea to follow it as closely as possible as you prepare to buy a home. Doing so can leave you with more breathing room for other costs that come with homeownership.