The front end ratio is a tool that underwriters use to determine whether someone should qualify for a home loan or not. It is just one of the many equations used when evaluating a potential borrower for a home loan. According to the financial website Investopedia, the formula for front end ratio is total monthly housing expenses divided by monthly income.
Purpose
The main purpose of the front end ratio is to find out if a potential borrower is capable of making the monthly payments that the loan would require. It is also a form of protection for the lender because analyzing the front end ratio minimizes the risk that the lender would take. The front end ratio can also be used to determine how much of a loan the potential borrower should qualify for.
Monthly Housing Expenses
In the front end ratio equation, monthly housing expenses are used to determine how much a person can afford to pay for a mortgage. The real estate website Trulia explains that monthly housing expenses in the front end ratio include monthly mortgage payment, mortgage insurance, property taxes, homeowners insurance and homeowners association fees, if applicable. These expenses are all ongoing costs, and if the ratio is too high, it means the potential borrower might not be able to afford the payments.
Monthly Income
When monthly income is taken into consideration for the front end ratio, gross monthly income, which is money before tax, is used. If a couple is borrowing rather than an individual, then both of their incomes are taken into consideration. Though income changes when people change jobs or positions, front end ratio is just a snapshot of the current conditions.
Requirements
The requirements for front end ratio vary depending on the lender, how tight the financial market is at the time and what type of loan the borrower is applying for. The real estate website Trulia states that for FHA loans, which are backed by the Federal Housing Administration, lenders generally require about a 31 percent ratio in order to make the home loan. The requirements also vary based on the person's credit score; if a potential borrower has an excellent credit score, he may be able to get a loan with a higher front end ratio than lenders normally like to see.
If Your Ratio is Too High
Trulia explains that a potential borrower can still get a loan if his front end ratio is less than perfect, but it may take some time to get approved. If you want to get a home loan and your monthly housing expenses are too high, you cannot change your front end ratio unless you get a better-paying job or find a less expensive house, but you can change your back end ratio. The back end ratio is similar to the front end ratio, but instead of monthly housing expenses, back end ratio considers total monthly debt such as auto loans and credit card debt. You can improve back end ratio by paying off credit card loans or having student loan payments deferred. Lenders may let you get by with a high front end ratio if your credit score and back end ratio are good.
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