Debt to Income Ratio: How It Works

Andrew Bell

Last updated: March 11, 2021

• 3 minute read

3 minute read

Your ‘debt to income’ is a good indicator of your financial health. Lenders will use your ‘debt-to-income ratio’ when considering your eligibility for a home loan or a personal loan. It can also be a good indicator for you to gauge whether your debt is under control. 

What is a debt-to-income ratio?

Your debt-to-income ratio is your total debts and liabilities divided by your gross annual income (income before tax). This will indicate to lenders your ability to manage debt repayments based on your current financial commitments and your income.

Let’s look at an example of how a debt-to-income (DTI) ratio may be indicative to a lender. If you are a couple that both earn $70,000 per annum ($140,000 combined) and wish to take out a mortgage of $400,000, your debt-to-income ratio will consider the following:

• $400,000 for the new mortgage
• $3,000 for your current credit card limit
• Outstanding HECS debt of $30,000
• Total debt = $433,000

The debt-to-income ratio will be: $433,000 / $140,000 = 3.09 DTI; this means that your total debt is 3.09 times your income.

What is considered a good debt-to-income ratio?

Having a high debt-to-income ratio will directly influence your ability to obtain a loan. Typically, a high debt-to-income ratio is a 6, though different institutions may have different rules about what they consider to be ‘high’. 

A low debt-to-income ratio is generally considered to be under a 3.6; a DTI under this amount demonstrates that you have the ability to successfully manage debt. If you have a low DTI, you will likely have more loan options and be offered a more attractive interest rate on your personal loan and home loan applications.

What factors influence your debt-to-income ratio?

Debts considered

When calculating your ‘debt’ in the DTI ratio, the following financial institutions are considered:

• Your credit card
• Any micro-financing or instalment plans (buy-now-pay-later services etc.)
• Personal loans
• HECS/HELP loans
• Car loans or other asset finance
• Home loans
• Investment loans, lines of credit or margin loans

A general rule, if you are unsure what factors will influence your ‘debts’, is that if it does not appear on your credit report, it will likely not impact your debt-to-income ratio. Your credit report details your credit history and provides lenders with a ‘credit score’. 

Income considered

The ‘income’ that is considered when calculating the ‘income’ of your DTI ratio includes:

• PAYG (gross income before tax). This excludes any compulsory superannuation payments
• Self-employed (net profit before tax)
• Other income including casual, contract, commission, bonuses rental, overtime (gross – before tax)

How to improve your debt-to-income ratio

If you have a high debt-to-income ratio, you may wish to improve your debt-to-income ratio before applying for personal finance or for a mortgage. To put it simply, to improve your debt-to-income, you must either reduce your monthly debt payments or increase your total monthly income. There are a few ways you may be able to do this. In order to decrease your debt repayments, consider the following:

• Improve your credit score to renegotiate any current debt repayment fees with your lender
• Create and stick to a budget to reduce any unnecessary spending
• Utilise debt reduction strategies – this could include opening an offset account linked to your mortgage, making additional loan repayments or consolidating any current personal debts
• Look at refinancing your loan and finding a more competitive interest rate

To increase your income, consider:

• Taking on a casual job in addition to your current employment
• If you own a rental property and have a new lease coming up, consider raising your rental price 

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