What is the Front-End Ratio?
The front-end ratio, also known as the housing ratio, is a metric used in the mortgage underwriting process. It measures the monthly housing expense as a percentage of the borrower’s gross monthly income.
Why is the Front-End Ratio Important?
Lenders use the front-end ratio to assess the risk level of borrowers defaulting on their loan. A low front-end ratio means the borrower has a higher likelihood of managing and meeting their monthly mortgage payments based on their income.
How is the Front-End Ratio Calculated?
The formula for calculating the front-end ratio is simple:
Front-End Ratio = (Monthly Housing Expense / Gross Monthly Income) x 100
The monthly housing expense typically includes mortgage payments, property taxes, homeowners insurance, and sometimes HOA fees.
Inspiring Example 1: Jameses’ Mortgage Application
Let’s take a closer look at how the front-end ratio works in real life. The Jameses are applying for a mortgage to buy a new home. Their required monthly payment, including escrow payments, is $1,500. Here’s how their front-end ratio is calculated:
Mr. James earns $9,000 per month. Unfortunately, Mrs. James does not currently have an income. Now, let’s plug these numbers into the formula:
Front-End Ratio = (1,500 / 9,000) x 100 = 16.7%
This result, 16.7%, is comfortably within the typical maximum limit imposed by lenders for this type of loan.
Frequently Asked Questions (FAQ)
Q: What is the typical maximum front-end ratio allowed by lenders?
A: Most lenders prefer a front-end ratio that does not exceed 28%-% it’s a standard guideline. Being within this limit increases the likelihood of loan approval.
Q: How does the front-end ratio differ from the back-end ratio?
A: While the front-end ratio only considers housing-related expenses, the back-end ratio takes into account all of a borrower’s monthly debt obligations, including housing, car loans, student loans, and credit card payments.
Q: Can improving my front-end ratio increase my chances for a loan approval?
A: Absolutely! Ensuring your monthly housing expenses are a lower percentage of your gross monthly income can significantly improve your creditworthiness in the eyes of lenders.
Related Terms: Back-end ratio, Qualifying ratio, Debt-to-income ratio, Loan underwriting, Escrow payments.
