The front-end ratio compares monthly housing expense (PITI—principal, interest, taxes, insurance, plus HOA or PMI) to gross monthly income. The back-end ratio compares all monthly debt obligations (housing expense plus car payments, student loans, credit card minimums) to gross monthly income. Conventional loans typically require 28% front-end and 36% back-end maximum. FHA allows up to 31%/43%. VA primarily uses the back-end ratio at 41%.
A borrower earns $6,000/month gross. PITI is $1,500 and other debts are $300/month. Front-end ratio = $1,500 / $6,000 = 25%. Back-end ratio = ($1,500 + $300) / $6,000 = 30%. Under conventional guidelines (28%/36%), this borrower qualifies.
Memorize the conventional thresholds: 28% front-end and 36% back-end. Know what is included in each ratio—PITI for the front-end, and PITI plus all recurring debts for the back-end. Always use gross (pre-tax) income, never net income.
Related Terms
Related Concepts
Converting a percentage to a decimal involves dividing the percentage value by 100.
IRV stands for Income, Rate, and Value. It represents the relationship between Net Operating Income (I), Capitalization Rate (R), and Property Value (V).
Net Operating Income (NOI) is the revenue a property generates after deducting all operating expenses.
The gross rent multiplier (GRM) is a quick method for estimating the value of income-producing property by multiplying the property's gross rent by a factor derived from comparable sales. GRM = Sale Price / Gross Rent.
The capitalization rate (cap rate) is the ratio of a property's net operating income to its sale price, expressed as a percentage. It is used to estimate value and compare profitability of investment properties. Cap Rate = NOI / Value.
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