What is 'Front-End Ratio'
The front-end ratio is a ratio that indicates which portion of an individual's income is used to make mortgage payments. When lenders approve mortgages, the front-end ratio is calculated as an individual's monthly housing expenses divided by his monthly gross income, and is used in conjunction with the back-end ratio. By asking a lender what front-end ratio would be required for approving a mortgage, a borrower may determine how much he can allocate for monthly payments that include principle, interest, taxes and insurance (PITI) payments. Calculated as:
BREAKING DOWN 'Front-End Ratio'When deciding whether to extend a mortgage, lenders consider a debt-to-income (DTI) ratio even more important than having stable income, paying bills on time, and possessing a high credit score. One type of DTI ratio is the front-end ratio. It is comprised of how much a borrower would be spending on monthly mortgage payments, real estate taxes, homeowner’s insurance and association dues, if applicable.
When calculating a front-end ratio, anticipated housing expenses are added up and divided by the borrower’s gross monthly income, then multiplied by 100. For example, Sarah’s housing-related expenses are $2,000 and her monthly income is $9,000. Therefore, her front-end ratio is approximately 22%.
Recommended Front-End Ratios
Lenders prefer a front-end ratio of 28% or less for most loans, and 31% or less for Federal Housing Administration (FHA) loans. Higher ratios indicate increased risk of defaulting on the loan, due to greater monthly financial commitments and a potential inability to cover them all. However, factors such as down payment amount, savings and credit score may permit higher percentages when extending mortgages. For example, if a borrower has a 50% down payment or six months’ worth of housing expenses set aside, he may have a higher front-end ratio and still be offered a mortgage.
If a borrower’s front-end ratio is too high, he may pay off debt as a way of lowering the ratio. The borrower may also consider having a cosigner on a mortgage. For example, an FHA loan lets a relative with enough monthly income and a good credit score cosign for a mortgage.
Example of a Front-End Ratio
Student debt is preventing large numbers of millennials from purchasing homes. Even with excellent credit scores, many millennials believe their front-end ratios will be too high for lenders and they will be denied a mortgage. However, debt can be restructured so that it makes less of an impact on a potential homeowner’s DTI. For example, the monthly payment on a student loan may be lowered. Also, federal student loans may allow payments that comprise only 10% of a borrower’s income.