What is debt-to-income ratio? And why do lenders care about it?

APRA (aka the lending watchdog) reveals almost one in four new mortgages are risky. How are they deemed risky? Well, it’s got something to do with your debt-to-income ratio, which we’ll explain in this week’s article.

Your debt-to-income (DTI) ratio might sound complicated, but it’s really very simple to work out.

DTI is basically a number used by lenders that compares your total debt to your gross household income. The formula is: total debt / gross income = debt-to-income ratio.

So if you’re seeking a $700,000 home loan (and have no other debt), and your gross household income is $160,000, your DTI is 4.375 – a ratio most lenders would be very comfortable with.

So why do lenders care about your DTI?

The December quarter data just released by the Australian Prudential Regulation Authority (APRA) shows 24.4% of new mortgages have a DTI ratio of 6 or higher.

At the 6+ ratio, APRA (aka the banking watchdog) deems these loans as risky. And they’re keen to see the percentage of these loans that lenders approve start to come down as they’ve been on the rise in recent years.

In the September 2021 quarter, for example, new mortgages with a DTI of 6 or higher were at 23.8%, while in the December 2020 quarter it was at just 17.3%.

“However, the rate of growth in the [most recent] quarter slowed,” APRA points out (probably with a sigh of relief) in their latest release.

So why has the percentage of risky loans recently risen?

The recent rise in high DTIs has most likely got a lot to do with the phenomenal price growth (and resulting FOMO!) we’ve seen across the country over the past 12-18 months. This coupled with the lack of wages growth has seen DTI’s increasing.

In fact, new 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.

The mean price of residential dwellings in Australia now stands at $920,100.

That’s a jump of $44,000 from the September quarter ($876,100), and a jump of $176,000 in 12 months from the December 2020 quarter ($744,000).

So with 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, which is what APRA alluded to above, and for our clients in WA this is less of an issue due to our lower median house price compared to NSW and VIC.

So how much can you safely afford to borrow?

There’s a fine line between maximising your investment opportunities and stretching yourself beyond your limits.

Especially with RBA Governor Dr Philip Lowe warning Australians to start preparing for higher interest rates.

That’s where we come in. Everyone’s financial situation is different. Some lenders will consider a loan application where a DTI is higher than 6 depending on the overall strength of the application. Talking to your broker is the easiest way to know which lenders may consider this.

So if you’d like to find out your borrowing capacity and options, get in touch today. We’d love to sit down with you and help you map out a plan.

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