What is the 35/45 Rule? A Comprehensive Guide to Understanding Your Housing Affordability

Most people will make one of the biggest financial decisions of their lives when they buy a house. To avoid overextending your finances, it’s important to know how much house you can actually afford. This is where the 35/45 rule comes in handy. This guide will tell you what the 35/45 rule is, why it’s important, and how to use it to figure out how much house you can really afford.

What Is the 35/45 Rule?

The 35/45 rule is a guideline that recommends your total monthly housing costs should not exceed 35% of your gross monthly income. Gross monthly income is your total pay before taxes and other deductions.

Your total monthly debt obligations, including your housing costs as well as other debts like auto loans and credit cards, should not exceed 45% of your gross monthly income.

So in short:

• Housing costs ≤ 35% of gross monthly income
• Total debt ≤ 45% of gross monthly income

This rule is meant to keep you from spending too much of your income on housing and other debts, so you don’t end up “house poor.” “.

Why Is the 35/45 Rule Important?

Following the 35/45 rule is important for several reasons:

• Avoids overextending yourself financially – The more of your income that goes to housing and debts, the less you have available for other goals like retirement savings, college funds, or rainy day money. Staying within the 35/45 rule helps prevent you from spending too much on housing.

• Reduces financial risk – If you lose your job or have an unexpected expense, having less going toward debts gives you more flexibility in your budget. This provides a safety net.

• Helps you qualify for the best mortgage rates – Lenders look at your debt-to-income ratio when approving loans. Keeping your ratios low improves your chances of getting approved and securing better rates.

• Makes room for other costs of owning a home. Besides your monthly mortgage, you’ll have to pay for utilities, repairs, property taxes, and homeowners insurance. The 35/45 rule accounts for these extra costs.

How to Use the 35/45 Rule to Determine Affordability

Figuring out your affordable housing budget using the 35/45 rule is straightforward:

1. Calculate your gross monthly income. This is your total pay before taxes and deductions.

2. Multiply your gross monthly income by 0.35 (35%) to find your maximum monthly housing costs.

3. Add up your estimated monthly costs for things like mortgage principal/interest, property taxes, homeowners insurance, and PMI. This is your total monthly housing cost. It should be equal to or lower than the figure from step 2.

4. Multiply your gross monthly income by 0.45 (45%) to find your maximum monthly debt obligations.

5. Add up your monthly debts including housing costs, auto loans, credit cards, student loans, and any other debts. This amount should be equal to or lower than the figure from step 4.

Let’s look at an example:

• Gross monthly income: $6,000
• Maximum monthly housing cost (0.35 x $6,000): $2,100
• Total estimated housing costs: $1,800
• Maximum monthly debt (0.45 x $6,000): $2,700
• Total monthly debts: $2,500

Since the total housing costs and debts fit within the limits calculated using the 35/45 rule for this sample income, this budget aligns with the guideline.

Key Factors to Consider

When using the 35/45 rule, keep the following factors in mind:

• Down payment – A larger down payment reduces the mortgage amount borrowed, lowering monthly costs.

• Interest rate – Lower rates reduce monthly mortgage payments, allowing more room in your budget.

• Loan term – A longer term lowers payments but increases total interest paid over the loan’s life.

• Location – Housing costs vary greatly by location. Adjust estimates accordingly.

• Existing debts – Current debts impact how much you can allocate toward housing.

• Retirement savings – Don’t forget to budget for retirement accounts like 401(k)s and IRAs.

• Lifestyle – Your individual lifestyle and expenses also influence your ideal budget.

Tips for Lowering Housing Costs

If your estimated housing costs exceed the 35% threshold, here are some tips to lower your monthly housing payments:

• Make a larger down payment to reduce the mortgage amount
• Shop around for the lowest interest rate
• Choose a longer loan term such as 30-year instead of 15-year
• Opt for a less expensive home or live in a lower cost area
• Request a property tax reassessment to potentially lower taxes
• Refinance your mortgage if rates have dropped since you got your loan

The 35/45 Rule: A Valuable Affordability Check

The 35/45 rule is a good starting point for figuring out your home-buying budget because it keeps you from going over your budget. It’s not a hard-and-fast rule, but it gives you a starting point to figure out if you can afford the house based on your income, debts, and other factors. It’s just a starting point; make changes to your budget based on your own needs. The 35/45 rule can help you feel more confident that you’re buying a home in a smart way if you plan ahead and do some math.