While the 30 percent rule is a common mortgage benchmark, it might not be right for you.
If you’re preparing to apply for a mortgage, it’s likely you’ve heard a lot of jargon already, like amortization or the carry-cost rule. You’ve also probably been told (perhaps from your parents and your agent and your mortgage broker) to consider the 30 percent rule. While the of-cited rule shouldn’t be your north star in the mortgage process, it’s still pretty important to the process. Here’s a closer look:
So, What is The 30 Percent Rule?
An oft-cited figure in the real estate industry, the 30 percent rule recommends 30 percent of your monthly gross income go towards housing costs. So, if you make $75,000 a year, you’d be able to afford a monthly payment of $1,875—right? If that figure feels uncomfortable, don’t worry. The 30 percent rule is just a guideline, not a tried-and-true rule.
It’s Just a Guideline…
The 30 percent rule is often criticized because it refers only to housing costs—the principal loan and interest, property taxes and homeowner’s insurance (including HOA and mortgage insurance)—and leaves out a whole host of factors, like what other debt you might have, and the ongoing costs of home renovation or repairs. What’s more, the 30 percent rule is often considered outdated, as it’s a benchmark borne from loan legislation passed 50 years ago.
…But You Shouldn’t Ignore It
“The challenge with just saying that it’s outdated is that it’s still relevant to how Fannie Mae and Freddie Mac approve loans today,” says Berenice Perez, a product associate at Bungalo Homes .” As of today, it still happens to be the only benchmark that is consistent across the board.”
Meaning, when an underwriter is reviewing your income and assets to grant you a mortgage, they’ll likely use the 30 percent rule to assess the size of the loan you qualify for—not what kind of payment is comfortable for you.
30 Percent of the Bigger Debt Picture
The 30 percent rule isn’t the only standard benchmark in the loan industry. It actually falls under a broader catch-all: the 50 percent debt-to-income ratio that governs most conventional loans. Meaning, your total debt—including student loans, a car loan, credit card debt, and your mortgage—can’t exceed 50 percent of your gross income. So, if you’re applying for a mortgage debt-free, you might qualify for more than 30 percent of your income. If you’re burdened by student loans or buried in credit card debt, you might qualify for less than 30 percent based on how much you still have to pay off.
A Note to the Self-Employed
For the growing number of self-employed individuals, qualifying for that 30 percent loan might be challenging.
People who are self-employed “are required to have a consistent two years of that type of income in order for [lenders] to even consider their income,” Perez says. “Whereas I could quit my job tomorrow and start a new job and, as long as there’s a salary, I could qualify with the new income I’m making.”
For individuals who are self-employed today, the best options are to be aware of the lead-time needed to get approved for a mortgage. Non-qualified mortgages are risky, but Perez says there are a growing number of these private mortgages available.
The Ultimate Mortgage Calculation
Qualifications aside, Perez says your current budget is probably the best barometer for deciding how much your mortgage should be.
If you can’t picture yourself spending $3,000 every month renting, then you probably can’t picture yourself spending $3,000 on a housing payment,” Perez says.
So while the 30 percent rule is important to know when qualifying for a mortgage, it’s not the be-all-end-all. The most important thing is to stay realistic about your spending capabilities—it will mean buying a home, and not a headache.