The Australian real estate market has been the focus of national and international attention for well over a year. Speculators keep one eye on statistical changes looking for signs of weakening or of a bubble about to burst. If you are thinking about buying a home for your family or as a safe investment, you are in good company.
This course of action makes sense, given the headlines that have been quoted for months. Hearing that the value of new loan commitments for investor housing has risen for 15 straight months or that these loan commitments rose by 6.1 per cent grabs attention. These numbers mark a record high of $11.0 billion.
While all the activity around the housing industry is exciting, you may be looking for factual information about various facets of the real estate industry. A vital element of the mortgage industry is the debt-to-income ratio.
What Does It Mean?
The debt-to-income ratio (DTI) is one of several factors lenders in Australia will look at to determine your creditworthiness when you apply for a home loan. Other factors include your credit history, capacity to service the loan, and the loan-to-value ratio.
Your debt-to-income ratio is calculated by taking your TOTAL amount of debt (not just monthly repayment amounts of auto loans etc.) and dividing it by your gross (before taxes) annual income from all sources. The score is your DTI.
You have a $10,000 credit card limit 10,000
Another $15,000 on your car loan 15,000
And have $200,000 mortgage + 200,000
$225,000 is your debt (D)
You earn $100,000 a year $100,000 is your income (I)
D÷I= DTI 225,000÷100,000= 2.25
Your DTI is 2.25, meaning your total debt is 2.25 times more than your income.
What is Considered Income?
There are several sources used to calculate your income for a DTI score.
- Your Pay – The amount you earn before taxes, not including compulsory super contributions
- Self Employed – Net profits before taxes
- Other Sources – such as Casual, Commission, Contract, Rental Income, Overtime Pay, Workplace Bonuses & Dividends
What Debts are Part of the DTI Calculation?
- Credit Cards
- Existing Mortgages
- Personal Loans
- Portfolio Loans
- Tax Debt
- The Buy Now-Pay Later Facilities Such as AfterPay
Are Any Debts Excluded from the DTI Calculation?
Typically, any contingent liabilities are not added to the DTI. However, list these on your mortgage application as they are used when lenders calculate serviceability.
These debts include:
- The company, Trust, and Partnership Liabilities
- HECS and HELP Debt
- Leases and Hire Purchases
- Outgoing Liabilities
- Trade Support Loans
How Does My DTI Effect My Borrowing Power?
Lenders use the DTI as a way to gauge your ability to repay your loan. In the example, the DTI of 2.25 is considered a good score. A lender would see this and believe that you would be highly likely to service the loan.
How High Can My DTI Score Be to Get a Loan?
Typically, lenders prefer you do not exceed 30-40 per cent of your income on loan repayments. Beyond that amount, lenders would see you as having an elevated risk of defaulting on your loans, especially during times of economic stress or if interest rates suddenly jump. So, a low DTI number will help give you a better chance of getting a loan.
Are DTI Limits a Good Idea?
The answer largely depends on the borrower. DTI restrictions can be beneficial if only to keep homeowners from financial ruin. However, DTI can negatively impact investors who are making purchases with long-term plans. Generally, these investors have or can get liquid assets if they are in danger of defaulting on a property loan.
Do Lenders Have a Cap on DTI?
Right now, some Australian lenders will go as high as seven for a DTI score, although six is seen as risky by some lenders. The low-interest rates have led many borrowers to take out larger loans for longer periods. Individual lenders have established ratios that may differ from others.
ANZ and the National Australia Bank have DTI caps of nine in place. Westpac and the Commonwealth Bank send applications with a DTI of seven or higher to credit departments for manual reviews.
Australian Prudential Regulation Authority (APRA) is attempting to mitigate the risks involved in lending. The focus on risks comes as regulators announce that 70 per cent of total credit extended to Australian borrowers falls into the category of risky.
Do All Lenders Use DTI When Making Loan Decisions?
While DTI is not the only factor considered, it is the measuring tool the big four banks, as well as smaller banks, use when deciding to approve an application for a mortgage. Generally, lenders who APRA does not regulate may be lenient about DTI, but they often take the score into account when making decisions about loans.
Why are My Living Expenses Important to Lenders?
APRA introduced limits on investment loan growth in 2014. Interest-only loans were a considerable concern at the time. In 2018, APRA removed its limits. However, the agency still wanted ways to limit debt in place. APRA highlighted how borrowers spent their money, requiring lenders to gather more information about living expenses, especially those of highly geared borrowers.
Lenders want a picture of how you spend your money. This gives them an indication of how likely you will be to repay the mortgage loan. However, this is just one of many factors that lenders consider to be important when deciding whether or not to approve a loan.
** Please Note**
The material presented here is for informational use only. It is not legally binding financial advice and should not replace a consultation with a finance professional.