Why Do Lenders Care So Much About My Debt-To-Income Ratio?

Your debt-to-income (DTI) ratio is only one part of a larger responsible lending strategy used by all Australian banks and lenders. Overseen by our banking watchdog, the Australian Prudential Regulation Authority (APRA), your DTI ratio stops banks and other lenders from offering loans to people who can’t afford to repay them.

Let’s look at what a DTI ratio is, why APRA recently changed some of its lending rules and why this is good for you (and your finances).

What’s a debt-to-income (DTI) ratio?

Your DTI is the amount of debt you have divided by your gross annual income. Lenders and other credit providers use it to determine your eligibility for credit.

Your debt is what you currently owe – home loans, personal loans, credit cards, buy now pay later and HECS loans.

Your income is your gross income – wage, salary, pay, commissions and rental income.

For example: You earn $100,000 a year and have debts totalling $468,000.

Your debt-to-income ratio is 4.68 ($100,000 divided by $468,000)

As a rule of thumb, your debt is considered as anything appearing on your credit report. Lenders will use your DTI calculation when evaluating your home loan application.

• Useful reading: Home loan pre-approval: how much should I ask for

Why does my DTI matter?

Your DTI ratio matters because it’s part of APRA’s responsible lending strategy.

It stops you from getting into too much debt, which is easy to do with so many credit options. Your long term ability to keep comfortably servicing your debt is at the heart of these rules and regulations.

And with housing prices booming across the country and interest rates remaining at all-time lows, APRA recently made some changes to their lending rules.

What changes did APRA make?

It’s APRA’s job to make sure banks and other lenders are following their responsible lending guidelines. Lenders have to do what APRA says, and that includes following new rules.

Effective November 1, when a lender assesses a home loan applicant’s potential borrowing capacity, they must include a buffer of 3 percentage points. Before November 1, it was 2.5%, but with rising house prices and continued low interest rates, APRA worried too many people were getting into too much debt.

What this means is lenders can’t lend to anyone who couldn’t afford to repay their home loan if it were 3% higher. If lenders fail to enforce this buffer, they’ll be penalised financially.

•  Useful reading: APRA Serviceability Rate Change

Aren’t low interest rates and rising house prices a good thing?

Yes, but not if you borrow over your capacity. On the surface, it might seem that APRA has made these changes to let first home buyers get onto the property ladder, but that’s not the case. It’s actually to stop people from getting themselves into a financially challenging situation.  

Announcing the changes, APRA Chair Wayne Byres noted, ‘More than one in five new loans approved in the June quarter were at more than six times the borrowers’ income, and at an aggregate level the expectation is that housing credit growth will run ahead of household income growth in the period ahead.‘

What is the impact on property buyers?

If you’re an existing borrower, these changes won’t impact you at all.

If you’re a new borrower, first home buyer or investor, your home loan will be assessed at the new rate. Interestingly, these changes are expected to affect investors more than first home buyers. This is because investors tend to use debt to finance new assets – known as leveraging assets – all their debt now has to pass the new serviceability buffer. First home buyers, on the other hand, are generally limited to how much they can borrow by their home loan deposit.

Worried about the impacts of APRA’s new serviceability rules? Talk to your broker today!