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Back End Ratio
The back end ratio is a method used to measure a borrower’s ability to service debts with his current income.
Also known as the debt-to-income ratio, lenders are known to have their own internal credit assessment policies to determine what is a comfortable enough ratio of an individual in order for them to do business with.
At times, government agencies might enforce this ratio to fall within a certain criteria in order for an applicant to qualify for certain types of loans.
The formula calculate back end ratio is: Total Monthly Debt Expense/Gross Monthly Income
Expense items to go towards debt expense include:
- Credit card bills
- Mortgage payments
- Personal loan payments
- Auto loan payments
- Child support
It takes into account all existing long term debt obligations of a borrower.
What’s important to note is that when an applicant is applying for a home loan, and back end ratio is used by the lender, the mortgage payments of the loan that the borrower is applying for will also be taken into account.
For example, if an applicant has a combined household income of $3,000 and a total relevant debt expense of $600, the back end ratio will be 20%.
If the lender has a limit of 36%, this means that the borrower will have a ceiling of $1,080 to work with. By deducting $600 from $1,080, we arrive at $480. This is the maximum monthly installment that the borrower can afford according to the lender’s evaluation.
At a fixed rate of 5% over 30 years, this would mean that the maximum loan quantum that can be approved is approximately $90,000.
This does not factor in loan to value restrictions.