What are repayment ratios and why are they important?

A ratio is the relationship of payments to income.  Loan information materials typically refer to a “front ratio” or “housing ratio” and a “back ratio” or Total Debt ratio”.

The front or housing ratio is the proposed monthly house payment, taxes, and insurance (PITI) divided by the monthly income of the applicant(s) before payroll deductions.  A front ratio of 29% is the goal of this loan product.  A higher ratio is acceptable if recommended by the lender and is based on good compensating reasons such as a credit score of 660 or higher or paying rent equal to or more than the proposed payment.  There are many other reasons to allow a higher ratio.

Example:  Principal & interest payment=$700, real estate taxes=$200, property insurance=$50, giving a total of $950.00 monthly housing expense.  Gross monthly income is $4,000.  The front ratio is $950/$4000 or 23.75%.

A front ratio or housing ratio of 29% or less is acceptable.  A higher ratio is acceptable if recommended by the lender and is based on reasonable compensating reasons.

The back or total debt ratio is the total monthly debt payments divided by the gross monthly income. This ratio includes the housing expense used in the front ratio plus all other monthly debt payments that will not be paid off within 6 months. 

Example:  housing expense (from front ratio) $950, car payment $350, monthly credit card payments $50, monthly student loan payment $150.  Total monthly debt payment is $1,500.  Income is $4,000.  The back ratio is $1,500/$4,000 or 37.5%. 

A back or total debt ratio of 41% or less is acceptable for this loan product.  

A higher ratio is acceptable if recommended by the lender and is based on reasonable compensating reasons.