If you’re in the market for a new home, then you’ve probably heard the term ‘front-end (FE) ratio’, which is a subtype of the more common debt-to-income (DTI) ratio.
But what is front-end ratio, and how does it affect your chances of getting good mortgage terms to buy your dream house in Australia?
We reveal it all below!
What Is a Front-End Ratio?
To put it simply, your front-end ratio represents your mortgage payments divided by your total earnings before taxes and is an indicator of your financial solvency.
Also known as a mortgage-to-income (MTI) ratio, lenders use this number to determine your capacity to repay the credit and remain fiscally stable.
The lower your front-end ratio, the higher the chances you will get approved for a good loan, as it means you have more disposable income for other expenses.
Note: If you are taking out a loan to invest in property, instead of buying a house, DTI becomes much less relevant as you can simply sell off the property to cover your debts.
How to Calculate the Front-End Ratio?
You can easily calculate your FE ratio by following a simple three-step front-end ratio formula:
- Determine your monthly mortgage payment amount, including the principal, interest, and any taxes and insurance costs;
- Add up all your regular income sources before tax, including salary, freelance earnings, and other contract, rental, and commission revenue;
- Divide your regular mortgage with your income to calculate your front-end debt-to-income ratio, which can be converted into a percentage.
As an example, your monthly front-end ratio will come up to 0.25 or 25% if you are receiving a total monthly income of $4,000 and your mortgage charges add up to $1,000.
However, Australian lending institutions look at your total debt sum before dividing it with your annual earnings to come up with the overall DTI. So, for instance, if you were a couple with yearly revenues of $200,000 taking out a $600,000 credit, your DTI would be 3.
Nowadays, the DTI cut-off point for most Aussie lenders is between 6 and 7. Therefore, if you need more funds, you will have to find other ways to improve your loan eligibility.
More to learn: Find out how to easily take out a home loan in Australia in 2022
Front-End Ratio vs Back-End Ratio
The front-end ratio calculation is only one half of the DTI formula, and when making their final decision on loan applications, lenders also calculate your back-end ratio.
While the front-end fraction reflects the income portion spent on mortgage payments, the back-end percentage looks at the money you need to cover all other financial obligations, such as credit cards, tax debts, student loans, and other personal debts.
By incorporating this number into the final DTI ratio, banks get a more holistic view of your financial situation to learn whether or not you can fulfil your debt obligations.
What Is a Good Front-End Ratio?
As a general rule, lenders prefer a maximum front-end ratio of around 30% and a back-end ratio of about 40%, so you are able to pay off your loan without any financial hardship.
Australian lenders also use a three-tiered DTI system to calculate the risks of default:
- Excellent DTI—up to 3, and guaranteed loan approval;
- Good DTI—between 4 and 6, and other loan criteria will apply;
- Risky DTI—above 7, and severely declined chances to get a loan.
Note: As of 2021, the Australian Prudential Regulation Authority has maintained that financial institutions should not approve loan applications with a DTI ratio higher than 6.
Now that you know how to calculate your front-end ratio and use it to determine your DTI, you will understand better what you have to do to get a home loan in Australia.
Ultimately, even if your DTI is not optimal, your application may get accepted if you deposit a substantial down payment, show proof of savings, or have an excellent credit score.
1. What is front-end ratio for investment property?
When getting a loan to invest in property, your DTI will not be a crucial factor in your application, as you can always sell the estate if you are unable to continue paying off the loan.
2. Does front-end DTI matter?
Your front-end ratio is a crucial part of your DTI ratio and a major factor considered by lending institutions as it shows your capacity to pay off your mortgage regularly and on time.
3. What is the highest front-end DTI for a conventional loan?
The maximum loan size you could obtain as an Aussie is around six or seven times your annual revenue, meaning you may be unable to get a loan with a DTI above 7. For more information on what is a front-end ratio and how it is calculated, read above.