A debt-to-income ratio (DTI) or loan to income ratio (LTI) is a way for banks to measure your ability to make mortgage repayments comfortably without putting you in financial hardship.
While it’s an adequate stress test for approving home buyers, it doesn’t always make sense for property investors, who can simply sell their investment property if they need to.
What is a debt-to-income ratio?
Your debt-to-income ratio is your total debts and liabilities divided by your gross income (before tax income).
Essentially, your DTI ratio takes into consideration your full debt exposure ensuring you can meet your home loan repayments today and in the future.
For example, let’s say you’re a couple each earning a yearly gross income of $80,000 each ($160,000 in total), you want to borrow $500,000, and your total liabilities are:
- $500,000 for the new mortgage
- A credit card with a monthly limit of $2,000
- Total debt: $502,000
The following formula would then be applied: $502,000 ÷ $160,000 = 3.14 DTI
What this means is that your total debt is 3.14 times your combined income.
Which lenders apply a DTI ratio limit?
- Non-bank lenders: Non-Australian Deposit-taking Institutions (ADIs) do not always apply DTI limits, because they are unregulated by the Australian Prudential Regulation Authority (APRA). However, they will often take DTI ratio limits into consideration when assessing loans. Our Home Loan Experts have all the tools regarding our large panel of lenders.
- ANZ: Applications where the DTI ratio is greater than 9 will no longer be considered home loans by ANZ.
- Commonwealth Bank: They monitor applications with a DTI higher than 4.5, while applications that are 7 DTI or higher need to be manually approved by their credit department.
- National Australia Bank: Their DTI ratio cap is 9 for all home loan applications and their Loan to Income ratio (LTI) cap is 7.
- Westpac: For DTI ratio of 7 or greater, your application will be referred to their credit department for further review.
- Other lenders: Other major and smaller banks and lenders set their own DTI ratio benchmarks, and are broadly in line with major banks.
Call us on 1300 889 743 or fill in our free enquiry formto find out more about your DTI.
We know how to get your home loan approved in this new debt-to-income ratio environment.
Is this considered to be a high DTI?
In the above case, this would generally be acceptable to most lenders.
Generally speaking, a DTI higher than six times a borrower’s’ income (6 DTI) is considered to be a higher risk that you will be put under financial stress if:
- Your financial situation was to change suddenly; or
- Interest rates were to rise dramatically.
How can we help if you have high DTI?
In cases of a high DTI ratio, we can usually help you apply with a major lender if there’s:
- High-income stability such as income mainly comprised of base income, net profit or consistent sources.
- High stability of employment with details of years in current employment, same industry or current business.
- PAYG: The gross annual income before tax. It excludes compulsory super contributions.
- Self-employed: Net profit before tax, after acceptable add-backs.
- Other incomes such as casual, contract, rental, overtime, commission and bonus will be gross (unshaded) income before tax.
- Credit cards.
- Personal loans.
- Portfolio loans.
- Existing mortgages.
- Tax debt.
- AfterPay and other Buy Now Pay Later facilities.
- Leases and hire purchases.
- HECS and HELP debt.
- Trade Support Loans.
- Company, partnership and trust liabilities.
- Other outgoing liabilities.
We’ll first discuss your specific circumstances that are contributing to the high DTI ratio such as relocation, bridging loans, or other incomes that are not able to be included in the calculations.
Once we’re satisfied that you’re able to meet the repayments on the home loan without hardship noting the high DTI, we’ll provide detailed comments backed up by strong evidence along with your loan application which is considered on a case by case basis.
However, there are quite a few lenders that don’t have DTI caps and that’s who we’re working with.
What income is used to calculate debt to income ratio?
Based on different income types, the following incomes are taken as income for DTI calculation:
What debts are included in the DTI calculation?
What debts are not included in the DTI calculation?
Typically, contingent liabilities/ debts are excluded from DTI calculation, these include:
Additionally, where liabilities are shared with a non-applicant (joint loans), they will be included at 100% regardless of percentage ownership (some exceptions apply).
While these liabilities are excluded from the DTI calculation, these will still need to be included in the home loan application as they are required for serviceability calculations.
Who is affected by debt-to-income ratios?
On face value, it makes sense that lenders would want to limit how much they allow you to borrow based on your income-to-debt ratio.
For example, if you earn $100,000, you generally cannot borrow more than $600,000.
For standard homeowners, this is a responsible lending practice, but for an investor, it’s not always reasonable when you consider their long-term plans.
For example, they may be making interest only payments for the first 3 years so they can maintain their cash flow for further investment opportunities.
Alternatively, they may be pursuing a negative gearing strategy.
The bottom line is that LTI caps don’t make sense for property investors because they can simply sell one of their investment properties if they are unable to afford their mortgage repayments.
Why did APRA introduce stricter DTI benchmarks?
Back in 2014, APRA forced lenders to limit investment loan growth to 10 per cent per year.
This was primarily for highly-geared borrowers, that is, investors with high debt-to-income ratios.
Interest only loans were particularly wound back, with approvals limited to 30 per cent of a lender’s total loan book.
This “speed limit” was removed in May 2018 as APRA became more satisfied with the ratio of investment loans compared to owner-occupied loan approvals.
Despite this, 2018 APRA data found that 10% of new home loans were over 6 LTI and accounted for around 31% of the value of new property loans in recent years.
The speed limit might be gone but the regulator is still pushing banks to limit credit growth for highly-geared borrowers.
Lenders first tried to do this by increasing investment rates for existing borrowers but they faced a lot of backlash, and good borrowers were unable to afford the home loan repayments.
Instead, many lenders introduced approval benchmarks based on DTI caps of around 6 or 7.
Along with this cap, lenders are now required to make more reasonable enquiries into living expenses than borrowers were previously required to declare.
Sharper focus on living expenses is the new normal
Your debt-to income-ratio is one thing but the way banks consider your living expenses is now more important than ever.
In fact, high living expenses can make or break your application along with a high LTI.
Try our living expenses calculator to get an idea of how you stack up as a home loan borrower.
What can I do as a borrower?
To prepare for your home loan application, it’s usually best you cut out or at least reduce unused debt facilities.
For example, if you have a $2,000 limit on your credit card but find that you rarely use this amount per month, consider cancelling it.
Another example is expenses that aren’t vital and can be easily cut from your spending such as entertainment subscriptions, going to the pub, gym memberships, going to music festivals or sporting events, or simply eating take-away on a regular basis.
Please call us on 1300 889 743 or fill in our free assessment form and we can weigh up your home loan options.
There are lenders out there that don’t apply debt to income ratios caps.
