Debt to Income Ratios (DTI) are a traditional measure used in financial analysis which have become more widespread in mortgage lending in recent years.
First applied by the major banks and then soon after by other credit providers, DTI has become a key plank in assessing mortgage credit. It is also a good starting point before diving into the detail of financial assessment.
A few years ago, lenders began to review applications that had DTI ratios above prescribed thresholds. Other lenders went further, stating that if DTI is greater than, say, 6 times annual income, the application would not be accepted.
Commercial lending has also seen a growing focus on these types of credit measures.
What is Debt to Income Ratio?
By definition, DTI takes into account the total borrowings of an applicant, regardless of the term or nature of a credit facility. Total borrowings will include credit card or consumer debt, vehicle or other asset debt, and other personal and property loans.
Let's consider the following example:
| CUSTOMER A | CUSTOMER B | ||
| Home Loan | 425,000 | Home Loan | 700,000 |
| Investment Loan | 600,000 | Investment Loan | 0 |
| Credit Card Limit | 15,000 | Credit Card Limit | 35,000 |
| Motor Vehicle Loan | 55,000 | ||
| Personal Loan | 35,000 | ||
| Total Debt | 1,040,000 | Total Debt | 825,000 |
| Salary Income | 175,000 | Salary Income | 175,000 |
| Rental Income | 35,000 | Rental Income | 0 |
| Total Income | 210,000 | Total Income | 175,000 |
| Debt to Income Ratio | 5.0 | Debt to Income Ratio | 4.7 |
How to calculate DTI
DTI simply divides Total Debt by Total Gross Income.
So in the example above:
- Customer A has a total debt of $1,040,000 / total gross income $210,000 = 5.0.
- Customer B has a total debt of $825,000 / total gross income $175,000 = 4.7.
Therefore, Customer A has a higher DTI than Customer B. (Though, it could be that Customer A has a better monthly cash position.)
As a measure, DTI ignores the cost or term of debt and provides a more draconian measure of creditworthiness. It is a more reasonable secondary measure, especially for customers with higher mortgage debt, including property investors.
Credit Implications of DTI
DTI are now applied as a risk-based measure in lending. For example, we are seeing an inverse relationship between the loan-to-value ratio (LVR) and the allowable DTI result. In other words, if you borrow above 70% of a property value, then expect the DTI to be capped at around 6 times.
This creates a further hurdle for first-home buyers and other buyers with lower deposits.
Many banks currently monitor mortgage applications with a DTI higher than 4 or 5. Applications with a DTI higher than that will be subject to credit approval.
Loan Pricing Implications
Where the DTI ratio is less than 5 times, Credit Providers will generally offer more competitive interest rates. Combined with a lower LVR, the interest rate offered might become even sharper. Talk to your MCP Finance Broker about how to prepare a property funding strategy for your scenario.
Contact MCP
1300 510 816 or your Finance Partner
enquiry@mcpfinancial.com.au
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