A simple hack to work out your borrowing capacity

There is a simple hack to work out your rough borrowing capacity. It’s based on a borrowers Debt to Income ratio (DTI). We detail how to work this out below.

Working out your borrowing capacity doesn’t have anything to do with how much equity you have. This is a common misconception. While you need equity or a deposit to get a home loan, your borrowing capacity is really all about the difference between your incomes and your expenses. The difference between the two can potentially be used to service debts. This is your borrowing capacity. Makes sense, right?

Each lender will of course add in their own buffers and shadings to this basic equation, and this is where things get murky.

DTI is a much simpler method to work out your capacity and has been adopted by lenders as a broad overlay to their more complex models to ensure borrowers must meet two separate hurdles / tests.

Debt to Income ratio – How to work it out

How do we work out DTI?  It is simply your total debts divided by your annual gross incomes. Here are 2 examples.

• You’re a single person earring $90,000 gross per year with a $350,000 home loan and a $5,000 credit card limit.

        DTI = ($350k + $5k) / $90K = 3.94

• You’re a couple, one of you earns $100,000 and the other $60,000. You have a $750,000 home loan, a $15,000 credit card limit and a $10,000 personal loan. You want to borrow $500,000 to buy an investment property and the property will rent for $1000 / week (which equals $52K per annum).

        Total debts including the future investment loan is: $750K + $500K+ $15k + $10K= $1275k

        Total income will be: $100K + $60K + $52K = $212K

        DTI = $1275K / $212K = 6.01

DTI x 6 Rule

A DTI of 6 or less generally means you should qualify with most lenders all things being equal. We use this DTI x 6 rule often in our day-to-day initial assessments of scenarios and you can too!

We find a DTI of around 6.5 – 7.0 is generally the limit of borrowings with mainstream banks assuming you have decent equity / deposit in the transaction and multiple sources of income. While not a hard and fast rule we find most lenders’ other serviceability tests will kick in at around this DTI level.

Some non-banks will go higher on a case-by-case basis, and we find even the most generous lender will cap out at around a DTI of 8.

We are also seeing more and more lenders offering better pricing for lower DTI applications with a DTI of less than 6 being the magic number.