The debt-to-income, commonly know as the DTI ratio is a formula that helps lenders estimate the amount of money they are willing to lend. This figure is based on the amount of long-term or reoccurring debt a borrower has accrued. Although the DTI ratio is not as well known as say, a credit score, lenders evaluate the DTI number just as heavily. However, keep in mind these lending rules of thumb were much more stringent before the subprime meltdown, now regulation seems to have tightened up once again. Now, back the subject at hand, the 28/36 rule is a formula that calculates the debt to income ratio.
Deconstructing the 28/36 rule
The 28 figure represents the [maximum] percentage of your monthly income allotted for housing expenses. Housing expenses include principal, interest, taxes, and insurance, or PITI. In other words, the aforementioned expenses should not exceed 28% of your monthly income. The 36 figure represents the [maximum] percentage of your monthly income allotted for housing expenses and long-term debt. Long-term or recurring debt includes car payments, average credit card payments, school loans, etc.
The 28/36 rule applied
Income: $45,000 annually/ $3750 monthly
28%= $1,050 monthly for housing expenses
36%= $1,350 monthly for housing expenses plus debt
Result: $1,350 - $1,050 = $300 allotted for monthly, recurring debt.
If your actual amount of debt is larger or smaller than this figure, your mortgage will be adjusted accordingly. Keep in mind this number fluctuates between lenders. With the boom of the housing market lenders were allowing up to 50% of income to be allowed for housing and debt. Now foreclosures are on the rise. Better to borrow safe than to be sorry in the end.
The information above is based on a conventional loan pre-subprime and post-subprime bust.
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