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The front end ratio is an expression of the relationship between a person’s monthly income and housing expenses. For renters, this includes the cost of rent and associated fees. Homeowners must consider mortgage, insurance, property taxes, and other costs that may arise. This calculation is commonly used with home loan applications to determine if an applicant can afford a loan. Legal standards may prohibit loans to people with a front end ratio that is too high.
Ideally, the target front end ratio shouldn’t exceed 0.3% to 0.33%, roughly a third of the borrower’s monthly income. Any more could be hard to afford, and might make a borrower vulnerable to default. Lower ratios can be more secure, and may allow people to pay off loans more quickly or save money while paying down a home loan. Bankers can use quick calculation tools to estimate housing costs on the basis of the asking price and how much the borrower plans to put down.
This looks just at housing costs, not other expenses. Another consideration can be the back end ratio, which looks at total recurring debt payments, including those associated with a house. Standards for a back end ratio can be higher, reflecting the fact that borrowers may carry car loans, student loans, and other debts. Banks may routinely loan to people with a back end ratio as highly as 0.4%.
Homeowners who want to qualify for participation in loan guarantee programs may need to provide information about their front end ratio. If the lender takes a risk on a high ratio, the borrower may not qualify for assistance because the loan doesn’t meet the standard criteria. This is an important consideration for borrowers who plan on using assistance to secure a loan. It may be necessary to look for a house that costs less in order to qualify, and to avoid being house poor, where the bulk of assets and monthly expenses are tied in the home.
People preparing to buy homes may think about the front end ratio standard as they prepare to look at available real estate. They need to consider how much they can afford, given how much they take home every month and current market conditions. Some buyers may prefer a lower ratio so they have more money to set aside for emergencies like job loss or sudden medical expenses. Actual take home pay, rather than gross income, should be used in these calculations to get a better picture of how much money is available.
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