How Tighter Lending Standards Could Impact Your Borrowing Capacity

In the year 2022 the property market is in flux more than ever and with the latest movements in rising interest rates, Australian banks are responding by tightening their lending standards. Banks like ANZ, Westpac, and NAB are lowering the DTI (debt to income ratio) for home loan applications they’re willing to accept.

DTI refers to the number representing the gap between your household’s yearly income and your debts and liabilities. Usually expressed as a single digit, banks use this metric to inform whether it would be financially responsible to lend to you or not. Working out your DTI is a matter of comparing how much you want to borrow with your annual salary – for example, if your total household income is $100,000 per year and the debt you are looking to take on is for $600,000, then your DTI would be 6. By this measure, borrowing a smaller amount, increasing your yearly income, or paying off debts are all ways you can reduce your DTI. Your debt to income ratio is also impacted by any other pre-existing debts you may have, and these should be added into the amount representing the loan you’re wanting to take out. This includes personal loans, credit card limits, existing mortgage debts, tax debts, HECS or HELP debts, and even any buy-now-pay-later services (yes, that means Afterpay). For instance, if you have a credit card with a limit of $2,000, then your debt when working out your DTI would be $602,000. Other considerations when working out your debt to income ratio include your dependents, your deposit amount, whether you are relying on a dual or single income, and other expenses.

In a nutshell, banks are now reducing the DTI they are willing to accept for home loans to ensure responsible lending. Where many banks would often loan out with a ceiling limit of 8-9 for a debt to income ratio, most now require 6-7 before requiring manual review and consideration. It means that borrowing capacity has been severely limited for buyers all across the market, and has especially impacted first home buyers who may have been working towards a DTI of 8 in order to take on a home loan and now are being asked to get it down to a 6. In fact, it’s impacted all borrowers – from investors to upgraders, everyone looking to take out a loan has been caused to pause and reconsider their approach to borrowing.

With interest rates rising, banks know that repayments are going to get more expensive as time goes on for borrowers (and particularly first home buyers). By having a lower debt to income ratio, there is some extra padding or a sense of “insurance” that even if rates rise, borrowers will be able to keep up with repayments.

First home buyers will need to return to the drawing board to figure out what their obligations will be, both in terms of income and in terms of lowering their debt, in order to obtain what would be considered a more favourable debt to income ratio. This doesn’t necessarily mean returning all the way to square one – it’s likely that if you’ve been preparing to take out a home loan, you’ve already been doing some of these things. It may just mean that your borrowing capacity has been limited, but not that you’re priced out of the market. Additionally, not all lenders have reduced their DTIs, so it’s still very possible to find a lender that will work with your current financial position.

If you’re unsure where you stand with your current DTI, seek out the advice of a mortgage broker who can talk you through the numbers and provide you with all the information for you to choose the best option.