Debt to Income Ratios ("DTI's") have been a part of financial analysis for a long time.
So whilst not new, we are hearing them as a language in mortgage lending. First the major banks, and now other credit providers drawing DTI's out as a key plank in assessing mortgage credit.
All of these lenders have been reviewing applications that have higher than DTI's ratios above prescribed thresholds.
Some lenders have now gone further, stating that if DTI is greater than say 8 times annual income the application will not be accepted.
We have also seen a growing focus on these type of credit measures in commercial lending too.
Definition
So what is it? By definition, DTI takes into account the total borrowings of an applicant, regardless of the term or nature of a credit facility.
Consider the following example:
| Customer 1 | Customer 2 | ||
| 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 |
DTI simply divides Total Debt by Total Gross Income.
So in the example above, Customer 1 has a higher DTI than Customer 2. ($1,040,000 / $210,000 = 5.0). Though, based on this limited information it is likely that Customer 1 has a superior monthly cash position.
So this measure ignores the cost or term of debt, and provides a more draconian measure of credit worthiness. A reasonable secondary measure especially for customers for higher mortgage debt, including property investors.
Credit Implications
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, borrow more than say 70% of the property value and expect the DTI to be capped at around 6 times.
This is a further hurdle for first home buyers and buyers with lower deposits.
Many banks currently monitor mortgage applications with a DTI higher than 4 to 5, and applications with a DTI higher than 6 or 7 will be subject to credit approval.
Pricing Implications
Where the DTI ratio is less than 6 times, Credit Providers will generally offer more competitive interest rates. Even sharper when this is combined with a lower LVR.
More Information?
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