In this article we look at what debt to income ratio (DTI) is. We also look at different factors the lenders look at when assessing your home loan application.
There are several factors credit assessors look at when deciding how much you can borrow and whether they will approve your loan application including your debt to income ratio. These factors include:
- Loan-Value-Ratio
- Servicing capacity
- Credit history and conduct
- Debt-to-Income Ratio
Recently, a couple of lenders announced they were decreasing their acceptable Debt-to-Income Ratio (DTI).
What is Debt To Income Ratio and why does it matter?
Simply put, the DTI refers to how much total debt you have divided by the gross income you earn per year.
Debt (D) takes into account the home loan you’re applying for, plus any existing debt such as HECS, car loan total owing (not just the monthly repayment in the borrowing capacity), and overall credit card limit.
Income (I) is your gross income earned, this includes all income sources including rental income, bonuses and commissions.
DTI is calculated by taking your total debt and dividing it by your annual income. For example, if you earn $100,000 per year (I) and have a credit card of $20,000 and a home loan of $200,000 (D) then your DTI is 2.2, meaning you owe 2.2 times what you earn.
The DTI is another prudential tool the lender can use to ensure you don’t get yourself into too much debt. By limiting your overall debt position, they are attempting to ensure you don’t exceed more than 30-40% of your income on loan repayments. This means you should at all times be able to meet your loan repayments comfortably and avoid hardship.
How does DTI affect how much I can borrow?
Most lenders in Australia are now using the DTI to limit how much they will lend you. For a lot of lenders the acceptable DTI is now between 6 and 7. This means some banks will lend up to seven times your gross income, although others will only go as high a six times your income unless there are mitigating factors we can use to show why they should lend you more.
This means you may have an LVR under 80% and your servicing is fine (that is, you have enough money to cover the loan repayments each month) but if the loan puts your DTI above 7 then they will decline your loan application.
Are banks flexible, or is a DTI up to 7 the limit?
Under certain circumstances some banks may allow a higher DTI for example if there are large amounts of surplus income left over within the serviceability component. Generally speaking, most lenders are becoming more and more strict on this ratio and mitigating factors have to be pretty compelling for them to go over this.
As at December 2021, APRA are stating a debt to income ratio over 6 is now considered risky lending. And this type of lending is currently on the rise. In their September 2021 quarter report, APRA noted that thanks to the low interest rate environment, people were taking out larger and larger loans. In fact, nearly a quarter of all borrowers over the quarter had a debt to income ratio above 6.
Are all the banks using a DTI assessment now?
Pretty much. Some are stricter than others who may be more lenient, or have a higher DTI in use. When you apply for your loan, our brokers can help you understand which lender is going to be best for you based on your needs.
Another tool the lenders use to reduce the debt to income ratio is a higher assessment rate. This means whatever interest rate you have been offered on the loan, they add a extra to in order to ensure you can cover loan repayments should interest rates increase. This has the added affect of limiting the total amount you can borrow. APRA are also bringing in new legislation that require the bank have additional cash buffers if they have a higher number of “risky” loans on their books. This may mean the banks simply limit how many of these higher risk loans.
Debt To Income Ratio and median property value
The average Australian salary is $84,968 (Source: ABC), contrast this with the median property value in Melbourne at $864,000 (Source: REIV, as at 30.07.2020) and you can see we have a bit of a disconnect. Based on the average salary and a DTI of 7, the maximum debt level is $594,776 which for makes buying around that median price a challenge.
Now more than ever, chatting with a broker about your lending position is really important. We live in an increasingly complex environment, you not only need to look at the lender and the interest rate, but each of the lenders have different assessment rates, acceptable DTI ratios and servicing criteria.