What is a Back-End Ratio?

The debt-to-income ratio, is also known as the back-end ratio is indicative of how much of a persons income monthly paid toward outstanding debts. Expenses such as child support, credit card payments, mortgage payments (insurance, taxes, interest, and principal) and other types of loan payments equal total monthly debt. Back-end ratio equals (Total monthly expense debts / Gross Income Monthly) x 100 is a formula used by lenders for the approval of mortgages in conjunction with front-end ratio.

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How Does a Back-End Ratio Work?

Mortgage underwriters use the back-end ratio as one of many tools used in the prospective borrowers assessment of the level of risk related to lending money. This ratio is important because it is related to the amount of the borrowers income that is owed to another company or someone else. Applicants are considered to be high-risk borrowers if a high percentage of their paycheck goes to pay off debt each month. Potential income reduction or job loss could cause bills that are unpaid to pile up quickly. The addition of a borrowers monthly debt payments and dividing them by the monthly income of the borrower reveals the back-end ratio. For instance, a borrower with a $5,000 monthly income (5,000x12=$60,000 annually) and a $2,000 monthly debt payment has a 40% back-end ratio ($2000 / $5000). If a borrower has good credit but a ratio up to 50%, some lenders will make exceptions, however a back-end ratio that is not in excess of 36% is generally what lenders prefer to work with. When it comes to approving mortgages, some lenders only consider this ratio, however others may use it along with the front-end ratio. Similar to the back-end ratio, another debt-to-income comparison mortgage underwriters use is the front-end ratio, but the biggest difference is that only the mortgage payment is considered as debt. By dividing the mortgage payment of the borrower by their monthly income the front-end ratio can be calculated. Based on the earlier example, lets assume that $1200 of the borrowers $2000 monthly debt is comprised of the monthly mortgage debt. 24% is what the borrowers front-end ratio would be ($1200 / $5000). Mortgage companies commonly impose an upper limit of 28% for a front-end ratio. If a borrower is known to possess other mitigating factors such as large cash reserves, reliable income, or good credit, some lenders will offer more flexibility on the front-end ratio in the same fashion as the back-end ratio. A borrowers back-end ratio can be lowered in two ways: (1) selling a car they financed, or (2) paying off credit card balances. If the borrower is applying for a refinance mortgage loan, and there is enough equity using a cash-out refinance to consolidate outstanding debt can reduce the back-end ratio. As a compensation for the higher risk that lender potentially face on a cash-out refinance, more often the interest rate is higher over the standard term rate. To avoid borrowers running up paid off debt balances in the future, most lenders will require that any revolving debt accounts be closed if a borrower was using a cash-out refinance for payoff.