Debt-to-Income Ratio: What is it and How Does it Affect the Home You Can Buy?

Borrowing power is an important thing to know when home buying and seeking a home loan in Australia.

When a bank looks at your home loan borrowing power, one of the key things they will calculate is your "debt to income ratio," sometimes shortened to “DTI”.

Its particularly important for first homeowners, who may have higher DTIs.

So, let’s understand what this is, and how it can affect your mortgage application.

DTI is used to work out a cap on your borrowing power

As we know, your borrowing power is how much a mortgage lender will approve for you.

The better your borrowing power, the better the house or investment property you will be able to buy.

A lender will look at these key aspects when assessing a home loan:

1. Your annual cashflow from reliable income sources
2. Your deposit or home equity
3. Borrowing at a reasonable LVR (leverage ratio or Loan to Value Ratio)
4. Liability and total debt levels, including existing mortgages, and consumer debts like auto loans
5. And your household expense levels

After the above factors are taken into account, the DTI is also within the calculations lenders use and acts as a sense check. Sense check measures such as DTI ratios, help a mortgage broker or mortgage assessor in the bank get a handle on “is this loan sensible, is it responsible?”

As part of YouBroker’s service, we help you navigate the home buying process and take into account your personal DTI calculations.

The monthly mortgage payments misconception

Many people think that working out what a mortgage payment amount might be and saying “I can afford that” is the most important thing.

Common things you might hear are:

1. “My rent is higher than that monthly mortgage payment, so I can afford that house!”
2. “I can afford that monthly mortgage payment, no worries!”

But, in reality, the mortgage application is assessed by the bank based on stress-tested levels of repayments, known as Assessment Rates.

This ensures that if mortgage interest rates were to rise, you as a borrower could still afford the mortgage payment in that position.

Like DTI, Assessment Rates are different from lender to lender. Some lenders are higher, and some are lower, based on the bank’s risk appetite and the portfolio of loans they have.

How can I work out my Debt-to-Income Ratio?

Debt to income ratio is, simply, how your total mortgage loan limits compared to your annual income and is an indicator of your financial situation.

For example, if you have a gross annual income of $100,000, a mortgage of $500,000 you have a DTI of 1:5 (one to five).

• [Total Household Gross Annual Income];
• Divided by
• [Total Limits of All existing and proposed Mortgage Loans], equals your
• “Debt To Income Ratio”

National Australia Bank (NAB) puts it like this:

“NAB’s responsible lending obligations include ensuring the level of debt a customer has is not unsuitable for their income level. This is measured by the Debt to Income (DTI) ratio. DTI is the customer’s debt and new home lending limits divided by their unshaded gross income.”

It may also be calculated as the percentage of your gross monthly income that goes to your monthly debt payments, which is also known as the ‘mortgage stress’ measure when its reported in the news or by a think tank.

In reality, lenders in Australia typically look at the DTI ratio when making a mortgage approval decision.

What is Included in Your DTI?

The debts in your DTI are based on:

• The total limits of the mortgage lending credit limit you have
• This is different from the outstanding balances of the mortgages you have, as limits are the higher amount that your loan is amortised to.
• Other debts (such as car loans) are typically taken into consideration in cashflow affordability calculations, known as “Servicing” Assessments.

How are consumer debts treated?

Liabilities and debts such as your credit card limits, credit card debt, car loans, student loans like HECS debt, other personal loans, and Buy Now Pay Later accounts (such as Afterpay) will be included as part of your overall servicing position.

A servicing position will assess your cash flow (income) versus all the repayments on the debts, and the potential repayments on any credit card limit that may occur if the credit card is “maxed out” to the limit.

Your DTI also includes all of your income, including self-employed income, and any investment property rental income. We’ll have a look at income in more detail below.

What income can go into a DTI Calculation?

Home loan providers can have different rules about what income is assessable for the mortgage application process.

Here is an overview of what income is seen as reliable and consistent so they are taken into account for DTI calculations:

• PAYG: Your gross annual income before tax, excluding super.
• Self-employed: Net profit before tax, after acceptable add-backs such as super contributions, depreciation and interest expenses. Some lenders now also focus on the Assessable Income (on your NOA or Notice of Assessment) as the main validation of your self employed income.
• If you have an investment property, this income will be taken into account
• If you are proposing to buy an investment property, this new income will be taken into account (it’s only fair, as the bank, is taking the new mortgage into account on the DTI also!)
• If you are PAYG, you may have other income such as overtime, commission and bonus will be gross (unshaded) income before tax. Commission and bonus income should be averaged over two years to get a reliable figure that the bank will accept.

What is an Ideal DTI?

As we know, a high DTI ratio is considered a bad thing in the bank’s eyes.

Most lenders have a DTI cap, that is they won't lend you more than 5 to 8 times your annual income. This is primarily so that they have a sense check in place that helps them not to lend at irresponsible levels that could cause harm to the customer, the bank itself, society and the property market as a whole. Some predatory lenders, however, will approve you for loans as high as 10 times debt-to-income. This has become more common as home prices have gone up. Thankfully, some major banks are now tightening their standards. For example, ANZ will no longer accept any applications that would send DTI over nine, and are unlikely to accept them over seven. Regulators are also considering limits/caps, although none have come into play yet.

Many Australians have DTI levels between 3-5x Annual Income.

Many things may affect a person’s DTI, based on life stage. For example, a DTI will be different based on...

• How many houses and mortgages a person has (i.e. if you have one own home versus a property investor with four investment properties)
• First Home Buyers will tend to have higher DTI’s as they are just starting out, and lending more at the beginning of their loan, with lower career incomes also.
• Older borrowers over 55 years of age are generally at lower DTI levels, as they have paid down mortgages over the last 20 plus years and have built up significant home equity.
• If you are later in your career, you are more likely to be in a senior position and have a higher income, which will help in the “income” aspect of the DTI ratio.

The percentage method is better for calculating your ideal DTI, which you should try to keep at 20 percent or lower. Any more than that and you will start to struggle. Some people may find the struggle worth it for investing in a home. However, you should look at both the percentage of your income that is going to creditors and your actual budget amount. By the percentage method, lenders will typically look for a DTI of 43 percent of your gross earnings or less. However, going this high, unless it's your only alternative, can result in financial hardship.

DTIs are different from lender to lender

The allowable DTI ratio varies from lender to lender.

At YouBroker, we have access to each lender’s DTI calculations and policy, so that we can understand your position and if you will be acceptable to the lender, and in what loan size, prior to application. This removes a lot of the pain and guesswork from applying to the bank.

For example, ANZ will no longer accept any applications that would send DTI over 9 times your annual income and are unlikely to accept them over 7.

Regulators such as a APRA and ASIC are also considering limits or caps, although no formal DTI rules are in place as yet each lenders and banks still need to make responsible lending a priority. APRA and ASIC are encouraging banks to limit credit growth and providing for highly-geared borrowers (with very high debt), especially overleveraged property investors.

Alongside DTI and as part of Responsible Lending reforms, household expenses became a much more scrutinised part of the DTI calculations process.

Non-Australian Deposit-taking Institutions (ADIs) have more discretion around DTI limits because they are unregulated by the Australian Prudential Regulation Authority (APRA) which focuses on banks (known as ADIs).

Even though they may not have to, most non-bank lenders will consider DTI ratio limits when assessing your home loan application.

YouBroker can help you navigate the DTI calculations

At YouBroker, we have all the tools regarding our large panel of lenders and what DTI caps they have in place. This allows us to inform you about what lender would be most likely to approve your home loan application at the amount (and interest rate) you are looking for.

Get started with finding your ideal home loan, faster at YouBroker.

How Else Does DTI Affect Your Mortgage?

As already mentioned, lenders tend to cap loan amounts at a certain DTI, typically six. Although, you probably want to go lower if possible.

Otherwise, DTI can absolutely affect what loan you can get in other ways. One very positive impact is that if you have a low DTI, it can at least partially overcome the issues resulting from a low credit score. Typically, you can't get a loan at all if you have a credit score less than 650, and some loaners have a limit of 700.

However, lenders take DTI into account. If you have a low DTI, then they may be willing to take a risk on a borderline or even low credit score. If you have a high DTI, then they may turn you down even if your credit score seems decent. A low DTI may even allow you to get a decent loan if you have bad credit. Although it will still cost you more in terms of fees and interest.

What Should You Do to Get The Best Deal?

Before applying for a mortgage, you should try and get your other debts lower, especially if you are refinancing and don’t need to expand your borrowing levels.

You can reduce debt to income ratio by:

1. Work to grow your income. Seek ways to increase your bonus agreement, annual salary or business revenue if you are self-employed. Tactics include seeking new employment and gaining new skills to justify higher wages.
2. Reduce total debts and credit limits even if it means temporarily reducing your discretionary expenditure. If you have credit cards, reduce the credit limit. For example, if you have a $10,000 limit on your credit card but find that you very rarely use the full credit limit, consider reducing the limit or cancelling the card.
3. Avoid taking on any new consumer debt. As a rule, keeping low debt for consumption is a good idea. We know BNPL and new credit card offers can be tempting, but if you want to prioritise having a property and therefore a home loan, just hit pause on taking any new debts out or on getting that slick new car. Instead, prioritise the home loan, for now, get that done, and reprioritise from there.
4. Put money in an emergency fund so that you don't have to, ideally, use your credit card for an urgent expense. Ideally, you want three to 12 months of living expenses.
5. Consolidate debt to get a lower interest rate, so you can accelerate the amount paid off each month. You can use YouBroker to help you easily get a quote on what interest rate is available to you on a consolidation loan.
6. Always pay your debts on time, and in the full repayment amounts. This will be reflected on your credit score and credit history. These factors influence your credit worthiness and are extracted and heavily considered when refinancing or going for a real estate purchase. As part of the mortgage application process, YouBroker extracts your credit report and helps you navigate your options.

Your Next Steps

YouBroker can help navigate the mortgage application and assessment process and take the guesswork out of getting approved.

We can help you calculate your current DTI, work out how much you can borrow before you have problems, and figure out your best home loan options with lender home loan rate comparisons.

As part of our service, we help you understand:

• Your funding position which shows key components such as Stamp Duty, the loan amount, and your downpayment or equity;
• Your property scenario (be that refinancing or purchasing) and what you can afford, or what official value your property is;
• Your borrowing power, including factors such as DTI and Assessment Rates which determine your borrowing power at each home loan lender.
• Analysing what home loan product provider offers the right fit for your goals and needs, with the right discount or mortgage rate.
• Help you to navigate the real estate buying or refinance process, so you stay ahead of each step and know the upcoming milestones and what to expect on your homeownership journey.

Start on your home buying journey here: https://youbroker.com.au/get-started