What is the 'Back-End Ratio'

The back-end ratio, also known as the debt-to-income ratio, is a ratio that indicates what portion of a person's monthly income goes toward paying debts. Total monthly debt includes expenses such as mortgage payments (principal, interest, taxes and insurance), credit card payments, child support and other loan payments. Lenders use this ratio in conjunction with the front-end ratio to approve mortgages.Back-End Ratio

 

BREAKING DOWN 'Back-End Ratio'

The back-end ratio represents one of a handful of metrics that mortgage underwriters use to assess the level of risk associated with lending money to a prospective borrower. It is important because it denotes how much of the borrower's income has someone else's name on it. If a high percentage of an applicant's paycheck goes to debt payments every month, the applicant is considered a high-risk borrower, as a job loss or income reduction could cause unpaid bills to pile up in a hurry.

Calculating the Back-End Ratio

The back-end ratio is calculated by adding together all of a borrower's monthly debt payments and dividing the sum by the borrower's monthly income.

Consider a borrower whose monthly income is $5,000 ($60,000 annually divided by 12) and who has total monthly debt payments of $2,000. This borrower's back-end ratio, then, is ($2,000 / $5,000), 40%.

Generally, lenders like to see a back-end ratio that does not exceed 36%; however, there are lenders who make exceptions for ratios of up to 50% for borrowers with good credit. Some lenders consider only this ratio when approving mortgages, while others use it in conjunction with the front-end ratio.

Back-End vs. Front-End Ratio

Like the back-end ratio, the front-end ratio is another debt-to-income comparison used by mortgage underwriters, the only difference being the front-end ratio considers no other debt than the mortgage payment. Therefore, the front-end ratio is calculated by dividing only the borrower's mortgage payment by his monthly income. Returning to the example above, assume that out of the borrower's $2,000 monthly debt obligation, his mortgage payment comprises $1,200 of that amount.

The borrower's front-end ratio, then, is ($1,200 / $5,000), or 24%. A front-end ratio of 28% is a common upper limit imposed by mortgage companies. Like with the back-end ratio, certain lenders offer greater flexibility on front-end ratio, especially if a borrower has other mitigating factors, such as good credit, reliable income and large cash reserves.

How to Improve a Back-End Ratio

Paying off credit cards and selling a financed car are two ways a borrower can lower his back-end ratio. If the mortgage loan being applied for is a refinance and the home has enough equity, consolidating other debt with a cash-out refinance can lower the back-end ratio. However, because lenders incur greater risk on a cash-out refinance, the interest rate is often slightly higher versus a standard rate-term refinance to compensate for the higher risk. In addition, many lenders require a borrower paying off revolving debt in a cash-out refinance to close the debt accounts being paid off, lest he runs his balance back up.

RELATED TERMS
  1. Qualifying Ratios

    A set of ratios that are used by lenders to approve borrowers ...
  2. Front-End Ratio

    A ratio that indicates what portion of an individual's income ...
  3. Principal, Interest, Taxes, Insurance ...

    The components of a mortgage payment. Principal is the money ...
  4. Qualification Ratio

    Ratio of debt to income and housing expense to income that is ...
  5. Front-End Debt-to-Income Ratio ...

    A variation of the debt-to-income ratio (DTI) that calculates ...
  6. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
Related Articles
  1. Personal Finance

    What’s Considered To Be A Good Debt-To-Income (DTI) Ratio?

    The debt-to-income ratio measures the amount of debt a person has compared to overall income.
  2. Personal Finance

    Mortgages: How Much Can You Afford?

    Answering this means number-crunching as well as factoring in other considerations and expenses.
  3. Personal Finance

    How to Use a Mortgage Calculator to Save Time and Money

    Calculate your monthly mortgage payment using the Investopedia's free calculator.
  4. Personal Finance

    How Much Mortgage Can You Afford?

    Here's how to determine what you should be borrowing to finance your home.
  5. Investing

    Debt Ratio

    The debt ratio divides a company’s total debt by its total assets to tell us how highly leveraged a company is—in other words, how much of its assets are financed by debt. The debt component ...
  6. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  7. Investing

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  8. Investing

    Understanding Leverage Ratios

    Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios - including the debt, ...
  9. Investing

    4 Leverage Ratios Used In Evaluating Energy Firms

    Analysts use specific leverage ratios to compare firms within an industry. A basic understanding of these ratios helps when evaluating oil and gas stocks.
RELATED FAQS
  1. What is the debt ratio for an FHA loan?

    Borrowing through the Federal Housing Administration requires individuals to provide proof of income as well as information ... Read Answer >>
  2. What is the difference between the debt ratio of a company and the debt ratio of ...

    Discover the different financial evaluation measures that are most commonly applied to individuals and corporations, respectively. Read Answer >>
  3. Why does the loan-to-value ratio matter?

    Learn how the loan-to-value (LTV) ratio is calculated, and why this metric is important to lenders when evaluating a home ... Read Answer >>
  4. What is the difference between debt to income and debt to assets?

    Understand the differences between the debt-to-income ratio and the debt to assets ratio as they apply to personal and corporate ... Read Answer >>
  5. What's considered to be a good debt-to-income (DTI) ratio?

    Your debt-to-income ratio helps lenders determine your credit worthiness. Find out how to calculate your score and whether ... Read Answer >>
Hot Definitions
  1. Financial Statements

    Records that outline the financial activities of a business, an individual or any other entity. Financial statements are ...
  2. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  3. Money Market

    A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. ...
  4. Block (Bitcoin Block)

    Blocks are files where data pertaining to the Bitcoin network is permanently recorded.
  5. Fintech

    Fintech is a portmanteau of financial technology that describes an emerging financial services sector in the 21st century.
  6. Ex-Dividend

    A classification of trading shares when a declared dividend belongs to the seller rather than the buyer. A stock will be ...
Trading Center