The back-end ratio, or total month debt ratio, is another debt tool that can help you to decide how much debt is too much in your financial situation.

Just like the front-end ratio, you will need your monthly mortgage payment, real estate taxes, homeowners insurance, and home equity line of credit (HELOC) minimum monthly payments (if you have one). Additionally, you will need the monthly payments you make to service your other debt (car loan/lease payments, student loans, credit cards, etc). You will be using the minimum monthly payments for each debt for the purposes of this ratio.

After adding all your monthly debt payments together, divide that total by your pre-tax monthly income. Here is an example:

Again, the back-end ratio is used by lenders to determine “safe” borrowing amounts. Conventional lenders use 36% and the Federal Housing Administration (FHA) uses 41% maximum percentage. Just as with the front-end ratio, the lower the better for you. In this example, while the front-end ratio was within conventional & FHA limits (though barely), the other debt pushes the ratio well above conventional and very close to FHA limits.

The back-end ratio has many applications, much more so than the front-end ratio that can only help you with housing related decisions. The back-end ratio can be used in any situation where there is potential for new debt. Also, if your ratio is too high, you know you will need to be more aggressive in a debt pay down plan. And, if your ratio is within the limits, it can help you decide how much you can really afford to pay for a new car, etc.

This ratio also can have a greater impact on a home buying or loss of job scenario than the front-end ratio. If you have a lot of additional debt bringing you above the back-end ratio, but your front-end ratio is within the limits, you still have a problem, especially if there is an income drop.

Our goal is to introduce you to some very simple ratios to help you more effectively manage and more importantly to eliminate your debt. Next time we will introduce you to another important debt ratio, loan-to-value.

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