Debt-to-Income Ratio: What is it and What Does it Mean?

What are debt-to-income ratios (DTIs)?

Your DTI is simply your total liabilities and debts divided by your gross annual income, calculated in order to reveal your full debt exposure. Banks and lenders use your DTI to ensure you are eligible for personal loans and can meet loan repayments in the future.

How to calculate debt-to-income ratios

The DTI calculation is simple to calculate if you know your total debts and your gross income.

Calculate by using this formula:

(liabilities + debts) ÷ yearly gross income = DTI ratio

Alternatively, you can also use a debt-to-income ratio calculator.

What income types are used to calculate your debt-to-income ratio?

Income considered in the calculator of your DTI ratio includes:

• Your gross income (pre-tax)
• Overtime pay and bonuses
• Casual/contract work income
• Commission
• Rental income from investment properties
• Dividends from share trading
• If self-employed, net profit before tax

What income types are used to calculate your debt-to-income ratio?

Income considered in the calculator of your DTI ratio includes:

• Your gross income (pre-tax)
• Overtime pay and bonuses
• Casual/contract work income
• Commission
• Rental income from investment properties
• Dividends from share trading
• If self-employed, net profit before tax

What debts are included in the DTI calculation?

As a rule of thumb, debts included in your income ratio DTI calculation only count if they show up on your credit report. These might include debts & liabilities such as:

• Your credit card debt (the amount you owe)
• Micro-financing or instalment plans, such as Afterpay or Klarna
• Any personal loans
• Car loans or asset finance
• HECS/HELP loans
• Home loans or mortgages
• Investment loans or lines of credit

Example of the DTI ratio

Faye and Dean are looking to take out a mortgage worth $750,000 on an Australian property. Currently, they both earn $125,000 a year, making their gross income $250,000. The couple also owns two credit cards with a combined monthly limit of $5,000.

They calculate their income ratio (DTI) using the following formula:

$755,000 ÷ $250,000 = 3.02

Faye and Dean’s DTI ratio is 3.02, meaning their total debt is 3.02 times their combined income.

But does this show good financial health?

What is a good DTI ratio?

DTI ratio is usually categorised as low, medium, or high:

• Low DTI: 3.0 or below, considered excellent
• Medium DTI: 4.0 – 6.0, considered good but not excellent
• High DTI: 7 – 9.0 or higher, considered risky

However, the big four banks in Australia have their own way of grading and accepting DTI. They also increase and lower their DTI limit depending on the changing interest rate, property values, market movements and other factors.

As of December 2022, here are the maximum DTI ratio accepted by the big four:

• ANZ: 7.5
• Commonwealth Bank: 7.0 (requires manual approval from their credit department)
• National Australia Bank: 8
• Westpac: 7 (your application will be referred to their credit department for further review)

How do banks & lenders use debt-to-income ratios?

As we’ve said, banks and lenders use your DTI to estimate your ability to pay and manage your personal loan repayments to ensure you can repay the money you want to borrow.

What to do if you have a high DTI ratio

If you’ve found yourself in financial hardship and are struggling to make your monthly debt payments with your gross monthly income, you’ll likely have a high DTI ratio.

With a high DTI ratio combined with a high credit utilisation ratio, you’ll struggle to secure a mortgage loan or car loan. If your gross monthly income is unlikely to increase over the next year, you’ll need to take the necessary steps to lower your DTI ratio.

To lower your DTI ratio:

• Devise a financial plan to pay off credit card balances.
• Make higher monthly debt payments to lower the amount owed. Increasing your monthly payments will go a long way in shrinking your personal debts.
• Discuss lowering your interest rates with creditors or mortgage lenders which will help you build savings that can be used to pay off monthly debt balances.
• Avoid taking on more debt while you pay down your current debt payments
• Increase the length of your mortgage to lower your monthly mortgage payments

How to calculate your combined monthly debt payments

Your total monthly debt payments are the combined monthly amount you owe creditors or lenders for the money you’ve borrowed. Types of monthly debt payments include:

• Mortgage or rent payments
• Credit card repayments
• Child support
• installment plans

To calculate your total monthly debt payments, check your monthly outgoings, including your mortgage payment or rent payment, minimum payments on credit cards, and any other debts. This will help you devise a plan to lower your DTI ratio and improve your loan application success.