The front-end ratio
calculates the yearly gross income devoted towards making the monthly payment, which consist of three components which are principal, interest and insurance.
If an employee earning those wages applied for a mortgage, his or her front-end ratio
would only allow for $630 in housing costs, which would include taxes, homeowner's insurance and home association dues, in addition to the monthly mortgage payment.
In line with other studies (Quercia, McCarthy, and Wachter 2003), we measure mortgage consumption in two ways: (1) as the dollar amount of the monthly mortgage payment, and (2) as the ratio of the monthly mortgage payment to monthly household income, referred to here as the front-end ratio. The monthly mortgage payment is derived from administrative data at the time of origination, and includes principal, interest, taxes, insurance, and private mortgage insurance.
As shown in Table 2, the average mortgage payment for borrowers in our sample is $815, based on an average purchase price of $102,007, with a resulting average front-end ratio of 22.6% (ranging from 7.7% to 51.6%).
(10) Most real estate lenders cap the front-end ratio at 28 percent and
Administration (FHA) will in some circumstances allow a front-end ratio
While both of these studies analyzed the correlation between the back-end ratio and default risk, an analysis of 179 FHA loans originated in Utah between 2000 and 2001 estimated the impact of a borrower's front-end ratio
If the lender says that the front-end ratio
cannot exceed 32%, this means that his PITI divided by his gross monthly income must equal 32% or less.
There are two mortgage qualification ratios widely used--the front-end ratio
and the back-end ratio.
The front-end ratio
(or housing-cost-to-income ratio) is monthly housing expenses (principal, interest, taxes, and insurance, or PITI) divided by gross monthly income.
(The front-end ratio
is the monthly housing debt (PITI) divided by the borrower's monthly gross income; the back-end ratio is a borrower's total monthly debt divided by monthly gross income.) Rather, we've found the nonhousing ratio - the difference between the front- and back-end ratio - to be much more reliable because it accurately measures the borrower's cash-flow situation.
Hans noted that front-end ratios
were lifted by a move in the sales mix toward higher-margin categories, especially digital photo processing.