By Louisa Sanghera, Director, Zippy Financial
Data from the lending watchdog reveals that almost one in four new mortgages are risky. How are they deemed risky? It’s got something to do with your debt-to-income ratio or DTI.
Your DTI might sound complicated, but it is simple to work out. Your DTI is a measurement used by lenders that compares your total debt to your gross household income.
The formula is… total debt / gross income = debt-to-income ratio
Here is an example:
If you are seeking a $700,000 home loan (and have no other debt), and you have $160,000 in gross household income, then your DTI is 4.375 – a ratio that most lenders would be comfortable with.
Why do lenders care about your DTI?
The December quarter data released by the Australian Prudential Regulation Authority (APRA) shows 24.4$ of new mortgages have a DTI ration of 6 or higher. At the 6+ ratio, APRA (the banking watchdog) deems these loans as risky, and they are keen to see the percentages of these loans that lenders approve to start to come down. That is because they have been steadily rising for a while now.
For example, in the September 2021 quarter, new mortgages with a DTI of 6 or higher were at 23.8% while in the December 2020 quarter, it was just 17.3%.
Why has the percentage of risky loans risen?
The recent rise in high DTIs has most likely got a lot do with the phenomenal price growth (and resulting FOMO) we have seen across the country over the past 18 months.
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.
So, with the 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.
How much can you safely afford to borrow?
There is a fine line between maximising your investment opportunities and stretching yourself beyond your limits. It is important to stress-test what you can borrow in the current financial landscape and also against any upcoming headwinds that are tipped to hit borrowers, such as interest rate rises and possible tightening lending standards.
Everyone’s financial situation is different. Some lenders will consider your circumstances and accept a loan application where a DTI is higher than 6.