During the home loan application
Why Your Debt-to-Income Ratio Matters in a Home Loan Application
When applying for a mortgage, lenders closely examine your debt-to-income ratio (DTI)—also known as a loan-to-income ratio. This figure helps them determine whether you can manage loan repayments without financial stress.
What Is a Debt-to-Income Ratio?
Your DTI ratio compares your total debt to your income. It includes debts like personal loans, student loans, and credit card balances. On the income side, it considers employment earnings and dividends from shares. Lenders usually express this ratio as a two-digit decimal.
How Lenders Use Your DTI
Lenders use your DTI to assess your serviceability—your ability to repay the loan. This evaluation supports responsible lending practices, as required by APRA. It also helps banks ensure they can recover the loan amount and interest.
How to Calculate Your DTI Ratio
Calculating your DTI is simple. Add up all your debts, including your proposed home loan. Then divide that total by your gross (pre-tax) income.
Income Sources That Count:
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Salary and wages
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Overtime and bonuses
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Casual or contract work
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Commissions
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Rental income from investment properties
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Dividends from shares
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Net profit before tax (if self-employed)
Debts That Count:
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Credit card balances
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Personal loans
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HECS/HELP loans
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Portfolio loans
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Existing mortgages
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Tax debts
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Buy Now Pay Later loans
Example DTI Calculation
Let’s say you apply for a $300,000 home loan. You also have a $10,000 car loan and a $2,000 credit card limit. If you earn $60,000 annually, your DTI ratio would be:
($300,000 + $10,000 + $2,000) ÷ $60,000 = 5.2
A DTI of 5.2 is generally seen as “good, but not great.” You may still qualify for a loan, but someone with a lower DTI could borrow more.
Things to Remember
The higher your DTI ratio, the less likely you’ll be able to secure the loan you want. A “high” DTI ratio of 9 or above makes it almost impossible to obtain a loan. Therefore, paying off other debts or loans before applying for a home loan is best. If you don’t have any other obligations, consider increasing your income to balance the ratio or exploring other options if the bank won’t lend you as much as you want.
As a general rule, a DTI ratio of 3.0 or below is considered excellent (low), 4.0-6.0 is considered good but not excellent (medium), and 7-9.0 or higher is considered risky (high).
While lenders’ maximum DTI ratios are not set in stone, they usually have guidelines. You can use these guidelines to determine which lenders may be suitable for you based on your circumstances.
What’s a Good DTI?
While there’s no hard and fast rule for what constitutes a good DTI ratio, many lenders consider a ratio of 43% or less to be acceptable. This means that your total debt payments, including your mortgage, should not exceed 43% of your monthly income.
It’s essential to remember that each lender may have guidelines for what they consider to be a safe DTI ratio.
Additionally, a lower DTI ratio may make it easier to qualify for a mortgage and could even help you secure a more favourable interest rate. Ultimately, working with your lender to determine the DTI ratio suitable for your financial situation is essential.
