Definition of "35 percent rule of thumb"
Have you heard someone talking about a 35-percent rule of thumb and you nodded acknowledging but the truth is that you had NO idea what in the world a “35-percent rule of thumb” means?!
We’ve all been there, my friend.
The 35-percent rule of thumb is a calculation practice that lenders make in order to determine the borrower’s risk. Actually, it’s sort of a euphemism to say they’re assessing the risk. The truth is that the 35-percent rule of thumb determines if the borrower can or cannot pay the loan. That’s why it's a “rule” and not an “estimation”. In fact, ever since the Mortgage Reform and Anti-Predatory Lending Act of 2010, the 35 percent rule of thumb has been upgraded to a law. By law, lenders can’t underwrite the loan unless they can determine the borrower will be able to pay up the loan.
The whole idea behind the 35-percent rule of thumb is this: a borrower can afford no more than 35% of its monthly take-home pay. So, let’s say that borrower Christie has a gross annual income of $50,000 and her take-home pay is $2,095 per month. That would mean that, under the 35-percent rule of thumb, Christie could not afford a monthly payment of $1,300 (35%) or higher, for instance. Usually, the workaround here is asking for a bigger down payment to water down the size of the installments, or extending the mortgage term, and mortgage payment scheduled in a way that it preserves the borrower’s finances and prevents the financial system from collapsing from irresponsible loans that are never paid and increasingly grow interest damaging in the process the economy as a whole.
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