Time to read : 4 Minutes
While there is such a thing as ‘good debt’, it needs to be manageable relative to your income.
This is often referred to as a debt-to-income (DTI) ratio, lenders will look at this figure when deciding whether to approve your home loan or other credit application.
The problem for many Australians, however, is that our debt levels have skyrocketed in recent decades, with recent data showing the average homeowner takes on a loan of more than 5.5 times their income.
Why your debt-to-income ratio is so important to lenders
Before applying for a loan, it’s worth calculating your debt-to-income ratio first.
To do this, tally up the total amount of your annual repayments (e.g. debts) and divide that number by your annual salary (e.g. income).
🧮 For example, if you earn $100,000 a year and have debts of $250,000 for a home loan and $30,000 for a car loan, then your DTI ratio is 2.8 – which means you owe 2.8 times the amount you earn.
💸 There are many different types of debts to factor into your DTI: credit cards, personal loans, student debt (HECS/HELP), tax debts, buy-now-pay-later loans, and any existing mortgages.
😟 Lenders are becoming more conservative in the debt-to-income ratios they are comfortable with, especially as APRA says one in four new mortgages are risky.
🔍 While some banks will still approve loans for lenders with a DTI of more than 6, it’s a good idea to reduce that ratio.
Be aware: Lenders will pay close attention to your personal loans – not just the amount, but the number of loans you are currently managing and how an additional loan may impact your ability to make repayments.
How to improve your debt-to-income ratio
In the wake of rising interest rates and APRA increasing its minimum interest rate buffer, lenders are being more restrictive about who they approve for home and personal loans.
Here are some suggestions for lowering your DTI and becoming a more attractive prospect to banks:
The fastest way to reduce your DTI is to eliminate debt. Could you pay off your credit cards in one hit rather than only covering the monthly minimum?
Alternatively, if you can increase your income then you can tilt the DTI ratio in your favour.
Remember that your ‘income’ includes not just your gross income (pre-tax), but also additional wages from overtime pay, bonuses, contract work, commissions and rental income from other properties.
If a pay rise or promotion are impossible right now, consider getting a side hustle. From ride-share and delivery services, to tutoring or even turning one of your hobbies into a side business, it could bring in some much-needed extra income.
The bottom line
Ultimately, lenders will assess your borrowing power on your debt-to-income ratio and your ability to service the loan.
💰So if it’s currently quite high, a few lifestyle changes could potentially bring it down.
It’s also worth speaking to a variety of lenders, as each will have their own limits on the DTI ratios they are willing to take on.
There’s no one-size-fits-all path to improving your debt-to-income ratio. It’s important that you work to understand your ingoings and outgoings, and speak to your lender about the maximum DTI they will accept for a loan.
Then work out what loan is the most serviceable for you.
Read more:
How to get faster pre-approval for your home loan
Can I get a home loan as an independent contractor?
