When deciding whether or not a potential client is a reasonable loan risk for a mortgage, lenders look at several factors. One of the factors is known as front-end ratio. In this blog, we’ll explain what front-end ratio is and show how to calculate it.
What is Front-End Ratio?
Front-end ratio is a person’s monthly mortgage expenses compared to their gross monthly income. Overtime pay and bonuses will not be included in gross monthly income. The expenses used in the calculation include:
- Mortgage principal
- Mortgage interest
- Taxes
- Insurance
- HOA fees, if applicable
Generally, lenders are looking for a front-end ratio under 0.28. Some lenders will disclose their preferred front-end ratio. Not meeting it doesn’t necessarily mean a definitive “No,” as some lenders will make concessions if other factors they look at are healthy.
Calculating Front-End Ratio
To calculate your front-end ratio, total the monthly housing costs you expect to incur and divide that number by your gross monthly income. Let’s look at an example:
- Expected monthly housing expenses: $1,100
- Gross monthly income: $4,000
$1,100 divided by $4,000 = 0.275
The front-end ratio is under 0.28, so generally an acceptable ratio for most lenders.
Front-End Ratio for Investment Property
Lenders may place more emphasis on your front-end ratio when financing a primary residence than an investment property. When considering a mortgage on investment property, lenders will weight your back-end ratio more heavily. Back-end ratio is more commonly known as the debt-to-income ratio.
Back-end ratio is calculated similarly to front-end ratio, but rather than including monthly housing expenses, most monthly expenses are included. These include:
- Monthly housing expenses
- Student, personal, auto, or other monthly loan payments
- Alimony or child support payments
- Minimum monthly credit card payments
- Other debts
Expenses typically not included are:
- Utilities
- Groceries
- Gas
- Taxes
To calculate your back-end ratio, total your monthly expenses (leaving out the typical exclusions) and divide that number by your gross monthly income (not including overtime and bonuses). Multiply the result by 100, and that’s your back-end ratio.
Lenders are typically looking for a back-end ratio of 0.35 or less. Just as with front-end ratio, falling afoul of a lender’s preferred back-end ratio doesn’t necessarily mean you’ll be denied a mortgage.
When calculating back-end ratio, will lenders take an investment property’s rental income as part of your gross monthly income? They might. If the property under consideration has a documented rental history or a rental appraisal, some lenders may count up to 75% of the documented or expected rent as part of your income.
Be Prepared
The more aware you are of what numbers a lender is looking for when considering you for a mortgage, the better prepared you will be to find the right investment property and to make the approval process as smooth and efficient as possible.
If you have any questions, Realized can help guide you. Schedule your consultation with us today.
