# Back-End Ratio

## What it is:

Banks use the back-end ratio to determine whether a mortgage applicant is a good credit risk.

The formula for the back-end ratio, generally, is:

Back-End Ratio = (All monthly loan payments + requested loan’s monthly principal and interest payment + monthly property taxes on proposed real estate + monthly homeowners insurance premium)/Gross monthly income

## How it works (Example):

For example, let’s assume John Doe wants to get a \$500,000 mortgage that comes with a principal and interest payment of \$2,400. The house costs \$1,200 a year to insure (\$100 a month), and the property taxes run \$6,000 a year (\$500 a month). John Doe also has \$250 a month in student loan payments, and a \$400 monthly car loan payment. John makes \$120,000 per year, or \$10,000 gross per month.

Using the information above, we can calculate that John Doe’s back-end ratio is:

Back-End Ratio = (\$250 + \$400 + \$2,400 + \$100 + \$500)/\$10,000 = 36.5%

## Why it Matters:

The back-end ratio is a way to evaluate a borrower’s credit risk. Many lenders use the ratio instead of or in conjunction with the front-end ratio, which also evaluates a borrower’s financial obligations in relation to his or her income (but is less conservative than the back-end ratio). Many lenders have a rule of thumb that a borrower’s back-end ratio should not exceed 36%, though a borrower with good credit puts lenders a bit more at ease in special cases.

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