When assessing your home loan application, your lender will look closely at your financial situation, including your employment history, your income and any assets, as well your liabilities – or debt – and your outgoing expenses. Your debt to income ratio (DTI) is an important factor in this process, which some lenders use to measure your ability to make repayments.
To determine whether or not you are able to make repayments on your home loan, lenders will take a close look at how much debt you have compared to your income. Many lenders will apply a debt to income ratio as a stress test for approving home buyers.
There are two components used when calculating DTI – a front-end ratio which includes only home-related expenses like mortgage, insurance, and taxes, and a back-end ratio which includes your other debt such as credit cards, personal loans, student loans and car loans.
DTI can be calculated as your total debt divided by your total Gross income x 100%.
The ideal front-end DTI is below 28 per cent while both front & back-end combined should be below 36 per cent. Most lenders consider a DTI higher than six times a borrower’s income as too high and likely to place you in financial stress if your financial situation were to suddenly change or interest rates increase dramatically.
Improve your chances
If you’ve been turned down for a home loan because of a high DTI you could consider doing the following:
- Before making your home loan application, it’s a good idea to reduce or cut out any unused credit cards or debt facilities. Remember, when it comes to credit card debt, lenders base their assessment on your credit limit rather than your credit card balance and view your credit limit as a future liability.
- The same goes for expenses that aren’t vital that can be easily cut from your spending – like eating out once a week or a magazine subscription. Now’s a good time to take control of those personal expenses with particular focus on luxury items.
- Pay off all your outstanding debt on time, every month.
- Regularly check your DTI using an online calculator like this one - https://www.finder.com/debt-to-income-ratio – to ensure you stay on track.
While all care has been taken in the preparation of this publication, no warranty is given as to the accuracy of the information and no responsibility is taken by Finservice Pty Ltd (Mortgage Express) for any errors or omissions. This publication does not constitute personalised financial advice. It may not be relevant to individual circumstances. Nothing in this publication is, or should be taken as, an offer, invitation, or recommendation to buy, sell, or retain any investment in or make any deposit with any person. You should seek professional advice before taking any action in relation to the matters dealt within this publication. A Disclosure Statement is available on request and free of charge.
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