Front-End Ratio

How Is Front-End Ratio Determined?

The front-end ratio, also known as the mortgage-to-income ratio, is a ratio that indicates what portion of an individual's income is allocated to mortgage payments. The front-end ratio is calculated by dividing an individual's anticipated monthly mortgage payment by his/her monthly gross income. The mortgage payment generally consists of principal, interest, taxes, and mortgage insurance (PITI). Lenders use the front-end ratio in conjunction with the back-end ratio to determine how much to lend.

Understanding the Front-End Ratio

When deciding whether to extend a mortgage, lenders consider the debt-to-income (DTI) ratio more important than having a stable income, paying bills on time, and having a high FICO score. One type of DTI ratio is the front-end ratio. In addition to the general mortgage payment, it also considers other associated costs, such as homeowners association (HOA) dues, if applicable. For example, a person's anticipated mortgage expenses are $2,000 ($1,700 mortgage payment and $300 HOA fees), and their monthly income is $9,000; as a result, the front-end ratio is approximately 22%.

Front-End Ratio vs. Back-End Ratio

The front-end ratio measures how much of a person's income is allocated toward mortgage expenses, including PITI. In contrast, the back-end ratio measures how much of a person's income is allocated to all other monthly debts. It is the sum of all other debt obligations divided by the sum of the person's income. Other debts commonly include student loan payments, credit card payments, non-mortgage loan payments.

Lenders prefer consumers to have a ratio of no more than 36% because of the associated risk of default. High back-end ratios indicate that more of the borrower's income is allocated to other debt obligations, making less income available for the mortgage. If the borrower's income is adversely impacted, there is a greater likelihood that they would be unable to fulfill debt obligations, including paying the mortgage.

What Is the Ideal Front-End Ratio?

Lenders prefer a front-end ratio of no more than 28% for most loans and 31% or less for Federal Housing Administration (FHA) loans and a back-end ratio of no more than 43%. Higher ratios indicate an increased risk of default. However, lenders may accept higher ratios when certain factors (e.g., substantial down payments, sizable savings, and favorable credit scores) are present. For example, if a borrower with a high front-end ratio pays half of the purchase price as a down payment or increases his savings substantially, lenders may be increasingly willing to offer a mortgage.

If unapproved, the borrower can reduce debts to lower the ratio. The borrower may also consider having a cosigner on a mortgage. For example, FHA loans allow relatives with sufficient incomes and good credit scores to cosign.

Special Considerations

Sizable student debt prevents many consumers from purchasing homes. Even with excellent credit scores, many realize that their front-end ratios are too high for lenders. However, borrowers can restructure debt so that it makes less of an impact on a potential homeowner’s DTI. For example, they may be able to lower the monthly payment on a student loan. Also, federal student loans may allow payments that use only 10% of a borrower’s income.