What Does Debt-to-Income Ratio Mean?

If you are considering a home loan or personal loan, or want to get a better sense of your finances, it may be helpful to work out your debt-to-income ratio. This can help you estimate if you have too much debt without having to wait until you realise you can’t afford repayments, or your credit score starts slipping. Plus, it’s relatively easy to calculate.

In our current environment with interest rates rising, those with a high DTI will need to pay particular attention. As they may face more stringent borrowing capacity constraints as a result.

What is a debt-to-income ratio?

A debt-to-income ratio is a personal finance measure that compares the amount of debt you have to your overall income. Lenders, including issuers of mortgages and other financial institutions, may use your debt-to-income ratio as a way to measure your eligibility for credit based on your perceived ability to manage repayments.

To calculate your debt-to-income ratio, you need to add up your total credit or debt balances and divide it by your total gross annual income (your salary or total annualised income each year before tax and other deductions are taken out).

As a hypothetical example, say you are in a couple and have a home loan of $400,000, a personal loan of $14,000 and a credit card of $4,000. You and your partner earn $80,000 each, annually.

This takes your total liabilities to $418,000, and your total gross income to $160,000.

Your debt-to-income ratio would therefore be 2.61 ($418,000 divided by $160,000).

Does NZ currently use debt-to-income ratios?

Currently, there is no set framework around debt-to-income ratios in New Zealand. But, the Reserve Bank has been mulling over the possibility of introducing one. After receiving submissions on their consultation around DTI ratio caps and minimum serviceability test interest rates for new mortgages, they have decided to press forward with establishing a DTI framework.

However, it won’t be introduced until mid-2023 at the earliest (if at all).

In saying that, lenders are able to use DTIs of their own, should they wish to. Last year both the BNZ and ASB introduced debt-to-income ratios (at around six to seven times income). However, to what extent these are still in use is unclear. Other banks have indicated that DTIs may form a part of their lending criteria or decision making. But again, the big lenders aren’t being particularly open about what this looks like.

So, to put it simply, DTIs are not currently an official part of lending criteria. But it’s likely that your lender will consider them (in some capacity) before approving any loan.

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What debt and credit facilities are considered in your debt-to-income ratio?

The debt and credit that financial institutions may look at when calculating your debt-to-income ratio include:

• Credit card debt (amount owed)
• Micro-financing or instalment plans, such as Afterpay or Zip Pay
• Personal loans
• Car loans or asset finance
• Student loans
• Home loans
• Investment loans, lines of credit and/or margin loans

Again, DTI ratios may be factored into any loan decision, even if they are not currently required by the Reserve Bank. But another common way that a lender will assess your loan affordability is by a debt service ratio.

Debt service ratio vs uncommitted monthly income

To calculate a debt service ratio (DSR), lenders take into account a prospective borrower’s income, and then subtract expenses and other liabilities to work out the loan amount the customer may be able to repay.

Essentially, how much money does a person have left over each week after they’ve paid all their bills, debts and expenses? And is that leftover amount enough to service a new loan?

Similar to a DSR is uncommitted monthly income (UMI). This assesses how much available income a person has after expenses and liabilities to spend on new loan repayments.

→Related article: How Much Can I Borrow to Buy a House?

Should first home buyers be worried about debt to income ratios?

Fortunately, first home buyers shouldn’t be too concerned about DTIs, for several reasons:

• FHBs are not the target market  – DTIs are intended to mainly target investors, who tend to be the ones borrowing at a high level
• The need for DTIs has somewhat shifted – rising interest rates and LVRs are already curtailing most high DTI lending, as higher mortgage repayments and the size of deposit required effectively limit the accessibility of high DTI loans for most FHBs
• DTIs aren’t coming anytime soon – as of now, DTIs are still a consideration for the RBNZ, and they are still a year away at the earliest. While some lenders may use DTIs, currently they aren’t the biggest hurdle for FHBs
• DTIs are designed to help reduce risky borrowing – it’s important to remember that if you’re being denied a loan, it’s because the lender feels you can’t afford it. While frustrating, it’s not always a bad thing. It’s better to be denied a loan than to take on debt you can’t manage.

→Related article: First Home Buyers: What to do if You Have Less Than a 20% Deposit

Looking for a home loan?

If you’re currently considering a home loan, the table below displays some of the 2-year fixed-rate home loans on our database (some may have links to lenders’ websites) that are available for first home buyers. This table is sorted by Star Rating (highest to lowest), followed by company name (alphabetical). Products shown are principal and interest home loans available for a loan amount of $500K in Auckland. Before committing to a particular home loan product, check upfront with your lender and read the applicable loan documentation to confirm whether the terms of the loan meet your needs and repayment capacity. Use Canstar’s home loan selector to view a wider range of home loan products. Canstar may earn a fee for referrals.

About the author of this page

This report was written by Canstar Content Producer, Andrew Broadley. Andrew is an experienced writer with a wide range of industry experience. Starting out, he cut his teeth working as a writer for print and online magazines, and he has worked in both journalism and editorial roles. His content has covered lifestyle and culture, marketing and, more recently, finance for Canstar.