The 28/36 rule of debt ratio is a simple measure that relates your monthly housing expenses and your monthly debt payments to your income. It is one of the factors lenders use to determine your eligibility for loans. Each number represents the maximum percentage of your monthly income that should be allocated to that expense category.
28: The Front-End Ratio
The number “28” in this ratio is also called the front-end ratio. This amount is calculated by multiplying your monthly gross income by 0.28. According to Bankrate, this figure is then compared to either your monthly rent or mortgage payment. Lenders generally want to see your housing expenses below 28% of your gross monthly income. So if your gross monthly income is $3,500, your house payment or rent should be less than $980.
36: The Back-End Ratio
The second number, 36, is also called the back-end ratio. It refers to the percentage of your monthly gross income that should be allocated to all debt, including your mortgage. If your gross income is $3,500, multiply that by 0.36. The result is $1,260. If your mortgage payment is $700, that leaves $560 for all other debt payments, including credit cards and vehicle loans.
If Your Debt Exceeds the 28/36 Ratio
Not all lenders will refuse to grant you a loan if your income exceeds the 28/36 ratio. Bankrate notes that some home loan programs will allow as much as 41% of your income to go to your total debt. Credit unions sometimes offer more favorable underwriting than conventional banks. However, the higher your debt-to-income ratio, the lower your credit score. This means that no matter what lender you apply with, your interest rate on a loan or credit card is likely to be higher.
How to Improve a Poor Debt-To-Income Ratio
Sonya Stinson of Bankrate recommends that you begin by cutting expenses, starting with your nondebt living and discretionary expenditures, and applying the extra money to paying down debt. If that does not create enough cushion in your budget, you may need to find a way to increase your income. Financial expert Dave Ramsey recommends paying off your bills one at a time, starting with the bill that has the smallest balance. This helps you to gain momentum as you apply the extra money created by paying off each bill to the balance owed on the next one.