Debt-to-income Ratios: The Lowdown
What does the planned debt-to-income ratio change mean for first-home buyers and property investors?
What is a debt-to-income ratio?
A Debt-to-income ratio measures the amount of debt an individual or household has compared to their income and provides a snapshot of their financial stability and ability to make regular mortgage payments. They are a key factor that mortgage lenders consider when deciding whether to approve a home loan application because they are an important measure of financial stability and risk. All debts that potential borrowers have would need to be included in the DTI calculation, including personal loans, credit card debt, and student loans, in addition to the mortgages they are taking on.
What is the Reserve Bank planning?
Back in 2021, the Labour Government agreed to give the Reserve Bank the power to set DTI controls on bank lending. This was at a time when concerns about high house prices were peaking. Currently, due to continued pressure on interest rates and the economy, the Reserve Bank is expected to implement restrictions on DTI within the next year. Despite the absence of an official announcement, the Reserve Bank has the authority to introduce these regulations at its discretion, as it seeks to strengthen the resilience of the economy.
DTI regulations will impose constraints on the extent to which borrowers can take on debt in relation to their income when taking on a mortgage. It could prevent banks from issuing new home loans to customers who had a debt-to-income (DTI) ratio of more than a certain level.
The final number has not been set, but the Reserve Bank will likely bring in a DTI of 6x or 7x annual income. For example, if the DTI was 6, borrowers who had an annual income before tax of $100,000 would only be able to borrow up to $600,000 for a house.
How Can I Improve My Debt to Income Ratio?
There are several ways to improve your DTI ratio. One effective way is to pay off debt, prioritising high-interest credit card balances and potentially negotiating lower monthly payments with creditors. Another approach involves increasing your income, which can decrease your DTI ratio by raising the denominator in the calculation. Additionally, refinancing debt can also lower monthly payments and improve your DTI ratio. This can include consolidating debt into a loan with a lower interest rate or extending the loan term, allowing for greater cash flow to put towards total debt reduction.
Are DTI ratios anything to worry about?
The primary concern on everyone’s mind is how DTI ratios will impact individuals and the real estate market. For first-home buyers, banks have already integrated similar restrictions and buffers to accommodate these ratios. Some banks have already proactively incorporated DTI ratios into their mortgage approval procedures. These ratios serve as a standard tool for mortgage lenders to evaluate the lending risk associated with individuals or households.
Property investors and homeowners with substantial mortgages are more likely to feel the effects of a debt-to-income ratio. These groups are often associated with purchasing properties at elevated ratios. If you fall into this category, it may be a good idea to chat with a financial adviser to find out what the best option is for you.
Also, certain exceptions exist for the DTI rules, new builds, for example, are exempt from these regulations. Therefore, if you’re investing in a new build, DTI restrictions won’t be a concern.
Summary
In conclusion, while the introduction of debt-to-income ratios may raise concerns, it’s essential to recognise that many banks already incorporate similar restrictions and buffers into their lending practices. DTIs are a common tool used by many mortgage lenders. Moreover, there are some exceptions to these rules. Individuals must stay informed about these changes, but overall, the impact may not be as alarming as it initially seems.
Consulting with trusted financial experts, like the dedicated team at Rapson Loans & Finance, can provide valuable insights and guidance tailored to specific situations. Get in touch with the team.