Debt-to-Income (DTI) Ratio: What’s Good and How to Calculate It

Many people who apply for a personal loan spend a lot of time focusing on their credit score and wondering how it might affect their applications. But what they might not realise is that their debt-to-income (DTI) ratio may be another factor that lenders are weighing up.

When an applicant has a high DTI, a lender may decline the application in some cases, or offer a reduced amount, even if the person has a strong credit history.

Here’s what you need to know about what a DTI is, how to calculate it and what sort of DTI lenders might have concerns about.

What Is a Debt-to-Income (DTI) Ratio?

A DTI can refer to two calculations.

The first, which is used in home lending, is the total amount of debt you have compared to your annual household income. The Reserve Bank sets limits around this for home loans. In that context, a borrower is high-DTI if they are an owner-occupier with debt over six times their gross annual income.

The second is the DTI ratio more often used in personal lending. It can refer to the ratio of monthly debt repayments to monthly income, which illustrates how much capacity you have to service a loan, and how much is committed to debt repayment.

This is used by lenders as a measure of affordability and the likelihood that you’ll be able to repay your loan without incurring hardship. If your DTI is lower, it may improve your chances of loan approval.

How to Calculate Your DTI Ratio

 A number of things are included in the “debt” side of the debt-to-income ratio 

• Existing personal loan repayments: If you are already paying off other debt, the lender will consider this in its calculation.
• Credit card minimum monthly payments: If you have a credit card, the amount you have to pay to service this will also be included.
• Buy Now Pay Later (BNPL) repayments: Even though it’s only short-term lending, your BNPL exposure will also be considered.
• Student loan repayments: Student loan repayments come out of your income before you receive it, but are part of the overall picture.
  
  

What counts as gross monthly income?

• Salary or wages before tax: Any income you earn from your job.
• Self-employment income: If you are self-employed or have a side hustle, this may be counted as income. Some lenders may want to see two years’ worth of financial statements to prove the reliability of this source of funds before it can be considered acceptable income for affordability calculations.
• Rental income: If you’re earning rent from a rental property, this can be included. Some lenders discount the rent received to 75 percent or 80 percent, to reflect the potential for vacancies.
• Work and Income payments: Money you’re receiving from Work and Income may be included in the calculation 

What Is a Good DTI Ratio for a Personal Loan in NZ?

Lenders will have individual approaches to a borrower’s DTI, but very broadly it may look like this.

There is no single universal threshold at which New Zealand lenders will be concerned about your DTI, and lenders will be looking at the overall picture in your application. Each lender has its own criteria and appetite, but we can help you to understand which may be appropriate for you.

Some non-bank and specialist lenders may be comfortable with higher DTIs. We can help you to assess whether this is suitable for you.

Common Mistakes When Calculating Your DTI

There are some mistakes that people often make when they calculate their DTI.

• Using your after-tax (take-home) pay instead of your gross income: It is usually your gross income that is used in the calculation, even though you lose some of that to tax each month.
• Forgetting to include BNPL repayments: If you have a BNPL facility, most lenders will include this in their calculations, even if you aren’t actually repaying a debt at the moment.
• Leaving out minimum payments on credit cards you rarely use: Your credit card needs to be included as part of your overall financial picture.
• Not counting joint debts that you are legally responsible for: If you have any loans with your partner, or other joint debts, it’s important to include these.

How to Improve Your DTI Before Applying?

There are a number of ways you can improve your DTI before you make an application for a new loan.

• Pay down existing personal loans and credit card balances where you can: Reducing the amount of other debt you have will improve your DTI.

• Avoid taking on any new credit in the lead-up to your application: This increases your debt and also may create a concern that you’re relying on credit to manage your financial life.

• Consider a debt consolidation personal loan: Sometimes it may be appropriate to consider combining a number of loans into one, lower repayment. There can be some things to watch out for, though, such as fees and the extra cost of a longer loan term. We can help you work out whether this is suitable for you.

• Hold off on applying until your financial position improves if your ratio is borderline: If you think you could improve your DTI in the short term and you’re able to wait to apply for a personal loan, doing so may help.

Frequently Asked Questions (FAQs)

Does getting rejected for a personal loan hurt your credit score?

It can do – we can talk to you before you apply to help you ensure your application has everything it needs to include and that you are in a suitable position to apply. We can also identify lenders who may have the appetite to approve the loan you want.

How many times can I apply for a personal loan? 

There is no limit to the number of times you can apply. However, you may find that a lot of applications within a short period of time could raise concerns as well as affect your credit score.

Can I reapply with the same lender after being rejected?

Yes, if time has passed or your situation has changed, you may well be able to apply again.

What credit score do I need for a personal loan? 

There is no hard and fast rule. Often, a better credit score can make it easier to get a home loan, but lenders will make their own judgements, and some are happier to deal with poor credit than others. We can advise you on this.

Will paying off debt improve my chances of loan approval?

It often can, if it reduces the commitments you have and frees up income to service a new debt.

Like to chat?

If you’re thinking about applying for a personal loan, get in touch with the team at better finance™ , we are personal loan experts and can answer any questions you have, whether it’s a query about DTIs or a concern about credit scores.

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.