Why Lender Care Your Debt-To-Income Ratio
Data from the lending watchdog reveals that almost one in four new mortgages are risky. How are they deemed risky? It’s got something to do with your debt-to-income ratio or DTI.
Your DTI might sound complicated, but it is simple to work out. Your DTI is a measurement used by lenders that compares your total debt to your gross household income.
The formula is… total debt / gross income = debt-to-income ratio
Here is an example:
If you are seeking a $700,000 home loan (and have no other debt), and you have $160,000 in gross household income, then your DTI is 4.375 – a ratio that most lenders would be comfortable with.
Why Do Lenders Care About Your DTI?
The December quarter data released by the Australian Prudential Regulation Authority (APRA) shows 24.4$ of new mortgages have a DTI ration of 6 or higher. At the 6+ ratio, APRA (the banking watchdog) deems these loans as risky, and they are keen to see the percentages of these loans that lenders approve to start to come down. That is because they have been steadily rising for a while now.
For example, in the September 2021 quarter, new mortgages with a DTI of 6 or higher were at 23.8% while in the December 2020 quarter, it was just 17.3%.
Why Has the Percentage of Risky Loans Risen?
The recent rise in high DTIs has most likely got a lot do with the phenomenal price growth (and resulting FOMO) we have seen across the country over the past 18 months.
Data released by the Australian Bureau of Statistics shows that in the 12 months to December 2021, residential property prices rose 23.7% – the strongest annual growth ever recorded.
So, with the property prices increasing at such a sharp rate and people stretching themselves to their limits to buy into the market, it has resulted in upwards pressure on high DTI percentages. The good news is that as the property market starts to cool, so too should the growth rate of risky DTIs.
How Much Can You Safely Afford to Borrow?
There is a fine line between maximising your investment opportunities and stretching yourself beyond your limits. It is important to stress-test what you can borrow in the current financial landscape and also against any upcoming headwinds that are tipped to hit borrowers, such as interest rate rises and possible tightening lending standards.
Everyone’s financial situation is different. Some lenders will consider your circumstances and accept a loan application where a DTI is higher than 6.
Frequently Asked Questions
What is Debt-To-Income Ratio (DTI)?
The Debt-To-Income (DTI) ratio is a measurement used by lenders to compare your total debt to your gross household income. The formula for calculating DTI is: total debt / gross income.
Why Do Lenders Care About DTI?
Lenders use the DTI ratio to assess the risk associated with a mortgage application. A high DTI ratio is considered risky, and lenders are keen to see the percentage of such loans come down.
What is Considered a Risky DTI Ratio?
According to the Australian Prudential Regulation Authority (APRA), loans with a DTI ratio of 6 or higher are considered risky.
Why Has the Percentage of Risky Loans Increased?
The rise in high DTI ratios is likely due to the significant growth in property prices, causing people to stretch their financial limits to buy into the market.
How Can I Safely Afford to Borrow?
It's crucial to stress-test your borrowing capacity against current financial conditions and upcoming changes like interest rate rises. Some lenders may accept a loan application where the DTI is higher than 6, depending on your circumstances.
How Can Zippy Financial Help Me Understand My DTI?
Zippy Financial can help you find out your borrowing capacity and options, and map out a financial plan tailored to your needs.
If you’d like to find out your borrowing capacity and options, get in touch with us today. We would love to sit down with you and help you map out a plan.
Zippy Financial is an award-winning mortgage brokerage specialising in home loans, property investment, commercial lending, and vehicle & asset finance. Whether you are looking to buy your first home, refinance or build your property investment portfolio, the team at Zippy Financial can help find and secure the right loan for you and your business.
About the Author:
Louisa Sanghera is an award-winning mortgage broker and Director at Zippy Financial. Louisa founded Zippy Financial with the goal of helping clients grow their wealth through smart property and business financing. Louisa utilises her expert financial knowledge, vision for exceptional customer service and passion for property to help her clients achieve their lifestyle and financial goals. Louisa is an experienced speaker, financial commentator, mortgage broker industry representative and small business advocate.
Louisa Sanghera is a Credit Representative (437236) of Mortgage Specialists Pty Ltd (Australian Credit Licence No. 387025).
Disclaimer: This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. This article is not to be used in place of professional advice, whether business, health or financial.