CBA debt to income ratio

CBA's introduced a debt to income ratio to their loan approval process. NAB have something similar in place, albeit with higher benchmarks.

In simple terms, a DTI ratio is kind of another 'servicing' check. Most people who fail the DTI ratio will fail servicing anyway, so it doesn't really impact many scenarios. In some countries, they run servicing tests purely based on DTI ratios. In Australia, all lenders use an income/expense model to test servicing rather than a DTI ratio.

From Saturday 26 May 2018 we will be monitoring applications with a DTI higher than 4.5, and applications with a DTI higher than 7 will be subject to credit approval.

What is a debt to income (DTI) ratio:

A debt to income ratio measures the level of debt a borrower holds against their income.
As a general principle, add all your gross income together (100k salary, 60k rental), and divide it by the total debt you have.

Who will this impact?

- Most borrowers would have DTI's less than 7, so this will really impact borrowers at the margins.

- That is, most borrowers will 'fail' servicing with CBA before reaching their '7' DTI ratio. That is because salary income is taken at a multiple of around 7 and rental income at around 5.5, making it quite rare to have DTI's above 7.

- Specifically with the way CBA's calculator works, it will likely impact borrowers with a lot of debt held with other institutions (OFI debt) and have negatively geared portfolios. I.e. investors that hold debt with other lenders. CBA 'punish' debt with other institutions a little less than other lenders. For those at the extreme end of this (all debt held elsewhere), this will impact their debt to income ratio.

- As an example, i've run a high income scenario for a borrower with a total income of around $650k. Their total debt allowed before being referred to higher credit would be around 4.5mill. However, assuming they hold $4mill of INV debt with other lenders already, this particular borrower may be able to borrow another $1.5mill in debt, pushing up their DTI to around 8.5. This means they will pass the '7' ratio if they borrowed more than 500k from CBA. Interestingly, if this same borrower had $4mill of OO debt, they wouldn't get anywhere near the 7 multiple. I.e. this DTI ratio under CBA calculator impacts investors with OFI debts.

- NAB in contrast, punish OFI debts equally to its own debts and have a higher DTI backstop. This means that there are far fewer cases where one will pass servicing but fail a DTI test.

Overall thoughts:

Its not a major change and won't really make that much of a difference. Also we don't really know what 'referred to credit' specifically means at this point, as most loans go to credit anyway! It is more substantial than NAB though and will impact more at the margins than NAB's DTI ratio.

 

A bit of a nothing announcement. I agree Redom, it will only affect people at the margins and then only those who are using the CBA tactically to take advantage of their servicing loopholes. I was in Macquarie's boardroom this afternoon, they'll be introducing a similar measure in the near future.

The NAB has had it for a while, I've yet to encounter a scenario where the DTI was the measure that stopped the deal.

If you are a person that's affected by this, it's probably a useful wakeup call that your lending strategy needs to change. The secret to being able to borrow more for investment is to change strategies before you reach a limit, rather than after the limit is reached. If this will affect your next application, then you need to rethink things before you make that application.

 

I feel that if your at the limit then it’s probably a good thing that you can’t keep borrowing. Buying can become addictive, and when we end up in normal interest rate territory 6%+ I think that a lot of investors will become unstuck. These limits protect us from ourselves a bit as with low interest rates it seems so easy but if we had normal interest rates I don’t think people would be as hungry for credit. Its just a pain for those who need to refinance

 

I dont know that it will require 6% rates for many investors to come under pressure. The re-setting of 4% - 4.5% IO loans to P&I will deliver the same sorts of outcomes that IO rates of 6% would deliver anyway.

Broadly speaking, the P&I re-set will add between 48%-58% (sometimes a little more) to monthly repayments. That's basically the same outcome as todays IO rates of 4%-4.5% going up by 50%


200K loan @ 4% IO for 5 years v 200K loan @ 4% P&I over 25 years . In this example the difference in repayments is @58.4% per month



300K loan @ 4% IO for 5 years v 200K loan @ 4% P&I over 25 years . In this example the difference in repayments is @58.4% per month




400K loan @ 4% IO for 5 years v 200K loan @ 4% P&I over 25 years . In this example the difference in repayments is @58.4% per month




If you do the same exercise at a different interest rate - say 4.5% for example- the difference is @ 48.3%. Not as bad as 58%, but still a very big increase.

200K @ 4.5% IO for 5 years v 200K loan @ 4.5% P&I over 25 years . In this example the P&I repayments are over 48% dearer per month





300K @ 4.5% IO for 5 years v 300K loan @ 4.5% P&I over 25 years . In this example the P&I repayments are over 48% dearer per month







And so it goes....

Now, we all know that rents arent going to cover these increases. No one is going to achieve 50% rental inflation . And aside from the minority, wage inflation probably isnt going to help much either- as its fairly well non existent for most. Its tracking at @CPI for most industries, and given the HEM's are indexed to CPI these days, wage rises are largely cancelled out by HEM's anyway.

So one of the hopes many investors will have is to either extend their IO term to buy themselves another 5 years, or refinance their IO loans elsewhere to buy themselves another 5 years... both of which are now difficult propositions given the IO quotas and servicing calculator changes...

So anytime any lender makes any move that closes off a potential escape route for IO investors who are facing a serious P&I cliff...I think its a notable change

As @Peter_Tersteeg has suggested.... you need to be planning to do things differently before this problem realises itself. By then it will be too late to make moves...and you may come under serious cash flow pressure and need to sell, right at the same time many others who have ignored 3 years of warnings are also trying to get to the exits.

The broad message stays the same - its time to bunker down and pay down some debt. These servicing calculator changes, which started 3 years ago and have been ratched up incrementally , are not being reversed. many hoped this would be temporary- its clear that its not. Instead, the changes are being consolidated, and any broker here will tell you that the word from the lenders is that there is going to be further consolidation to come. It will focus around living expenses and it will reduce capacity further for most. So those who have ignored debt reduction or cash flow until now should be reconsidering whether they should be changing tact within their portfolio to add a defensive hedge against loan repayment re-sets

 

With NAB if your LTI is at 7 or close to 7 you can be sure the loan will not service.

I'M yet to come across any applicants that can get their loan across at a LTI of 7.

 

So what does that tell you about future capital growth cycles?

And what does it tell you about the value of cash flow and debt reduction?

 

I think owner occs will be fine, and those with only 1 or 2 ips will manage, but when you have 3-4 properties that’s when you’ll really feel it. It is amazing how you manage to pay the essentials when the costs increase but your income doesn’t, somehow we have always made do even when we would have thought there was no possible way you always find the money when you need to, it’s amazing how much your lifestyle can adapt even when you think you live frugally you can almost always cut back on luxuries.
I wonder how many investors on this forum have been in the game for more than 1-2 cycles?
We only bought in the last 10 years, but the first property we bought on one income and we were paying something like 8% with Wizard on a self employed Lo doc, and before we bought that first house we thought the repayments were going to keep going up. Luckily we were able to refinance to the big 4 after a year but rates were still around 6% back then.

 

we'll know in @ 12-18 months, as more P&I rollovers flow through the system. I suspect younger O/Occs in Sydney and Melbourne who piled in using IO lending at peak prices may be a bit of a risk as well as investors with multiple IO loans rolling over...

But as @Redom was pointing out- the CBA's decision isnt a big big deal, it just puts that little bit more of a lid on any chance of a servicing calc reversal some are still holding out for....

 

True, I keep forgetting that FHB are dropping 600-800k on their first homes. I can see how they could easily get into trouble.

 

Nice post @euro73, elequantly said and always worth mentioning by brokers and finance experts to the broader public. In general though, its good to see that the RBA have devoted resources to working out the true extent of the problem and there's been some good solid data that has come out in recent months. I tend to agree with them, its a problem sure, but it'll be managed out relatively smoothly. Nonetheless the PC community have a larger portion of over leveraged borrowers than the wider public, so some of the more impacted will likely see your post and ideally begin preparing along the lines mentioned.

 

How exactly is DTI ratio actually calculated as the initial post would give you a percentage not a ratio?

E.g. $250000 income with 2.5m debt gives 10%?

 

That’s 10:1 in your example.

Based on gross income, not net.