What is a good debt-to-income (DTI) ratio? 2024 guide

In this article:

• What’s a DTI ratio?
• What should a DTI ratio be?
• What are the DTI limits in New Zealand?
• How have DTI restrictions affected mortgage deposits?
• What’s the average DTI ratio in NZ?
• How to improve your DTI ratio
• Finding the right DTI ratio for you

What’s a DTI ratio anyway?

A DTI ratio is one of the ways that lenders check whether you can afford a particular home loan. As the name suggests, it’s simply the amount you’re applying for divided by your income.

DTI ratio = amount borrowed ÷ annual income before tax

If you’re applying for a mortgage with someone else, such as your partner, you can use your combined incomes before tax.

Example: If you borrow $500,000 and have a household income of $100,000, your DTI ratio will be 500,000 ÷ 100,000 = 5.

What should a DTI ratio be?

A good DTI ratio is one that ensures you can afford a reasonable life and maintain your home loan repayments. So it needs to allow for a few luxuries, from time to time, possible interest rate increases and some of the unexpected financial challenges life can throw your way.

“Since people have different goals, a ‘good’ DTI ratio will vary from one person to another. If you’re planning to start a family or your own business, for example, a good ratio for you will be lower than it might be for others.” – Kaushik Gorasia, Financial Adviser, MTF Botany

To help protect their economies and financial systems, some countries have set a DTI limit, rather than leaving it up to each lender. In Ireland, it’s known as a loan-to-income ratio, which is set at 4 for first-home buyers and 3.5 for other owner-occupiers. This means that a first-home buyer’s mortgage can be no more than four times their annual household income.

However, like many other countries, New Zealand has chosen to consider all of your debts, not just the mortgage, when it comes to assessing affordability. This is called a debt-to-income ratio or DTI. So if you have other debts - such as a car loan, store credit, student loan, overdraft facility or credit card limit - they’ll reduce the amount you can borrow for a mortgage.

What are the DTI limits in New Zealand?

After two years of design and consultation, the Reserve Bank announced new DTI restrictions in June 2024.

The rules will only apply for new borrowing from banks for existing houses, not new-builds. Kāinga Ora loans will also be exempt.

The initial DTI rules will mean banks can lend:

• 20% of new residential mortgages to owner-occupiers with a DTI above 6
• 20% of new residential mortgages to investors with a DTI above 7

DTI example

Mathew and Alex are keen on a location that only has existing homes. So, to increase their chances of mortgage pre-approval, they want to stay below the DTI limit for owner-occupiers, which is six. Their combined annual income before tax is $120,000 and they don’t have credit cards or overdraft facilities. The only debt they have is $5,000 remaining on Mathew’s student loan.

DTI ratio = total debt ÷ combined income, so

The maximum total debt = DTI ratio x income = 6 x 120,000 = $720,000

To avoid the DTI restrictions, their mortgage can be up to $720,000 minus the $5,000 student loan debt = $715,000.

Mathew and Alex will still need a suitable deposit and certainty that they can continue to afford the regular mortgage payments over the coming years.

How have DTI restrictions affected mortgage deposits?

The new DTI restrictions are designed to reduce the economic risk of unaffordable debt increasing, particularly during rapid growth in house prices. It’s an added safeguard that allows the Reserve Bank to ease their loan-to-value ratio (LVR) requirements, allowing banks to provide more high-LVR (low-deposit) mortgages.

With the DTI restrictions in place, banks can lend:

• 20% (was 15%) of new mortgages for owner-occupiers with an LVR above 80% (deposit less than 20%)
• 5% of new mortgages for investors with an LVR above 70% (deposit less than 30%)

Exemptions

DTI and LVR restrictions don’t apply to new-build properties or Kāinga Ora loans.

What’s the average DTI ratio in NZ?

There’s no doubt that house prices and mortgage interest rates are challenging people’s budgets. For many, home ownership is simply not affordable at the moment.

Average mortgage-to-income ratio

Finding the average mortgage-to-income ratio for New Zealand is difficult, because the amount each household currently owes on their mortgage varies considerably.

However, a January 2024 report from Canstar looked at median house prices and household incomes around New Zealand. The median house value across the whole country was $790,000 and the average annual household income before tax was $132,000.

For someone with a 20% deposit, the 80% mortgage would be 790,000 x 0.80 = $632,000. In this situation the average household mortgage-to-income ratio in New Zealand would be 632,000

÷÷ 132,000 = 4.79.

Using regional values, the ratio would be 5.67 in Auckland, 5.00 in Wellington, 4.60 in Canterbury and only 3.18 in Southland.

Average value-to-income ratio

According to a February 2024 report from CoreLogic, in the last three months of 2023 the average home value (not the mortgage) was seven times the average annual household income in New Zealand. Over the previous 20 years, the average was 5.9 times. It varies between the main centres of course, with Tauranga now as high as 8.5 times and Auckland 7.7 times the average annual income. For Wellington it’s 6.2 and Dunedin is the lowest of the main centres on 6.0.

How much income goes to mortgage payments?

Another measure is income compared to mortgage payments. On average, during the last three months of 2023, 49% of household income went towards mortgage payments. This compares with a 20-year average of 37%.

On the other hand, the average rent takes up 21.6% of the average houshold income, according to CoreLogic’s research.

How to improve your DTI ratio

At a high level, improving your DTI ratio comes down to two things: You can apply for a smaller mortgage; increase your income somehow or do both. Since we use DTI restrictions in New Zealand, a third option is to reduce any existing debts.

Reducing your DTI ratio not only makes your mortgage more affordable, it can also save you a huge amount in interest over the life of your loan. If you need to get your DTI ratio down to increase your chances of mortgage approval or to better support your future goals, here are some ideas to help you get started.

How to reduce the mortgage you need 

Apart from the obvious option, which is choosing a less expensive area or type of property, reducing the amount you borrow means having a larger deposit. Let’s look at some ways to increase your deposit.

Save for longer: A year or two of serious saving can make quite a difference, particularly if house prices aren’t expected to rise too much in that time. Create a budget and track your spending to identify areas that could handle a trim. You could also consider earning more through an after-hours side gig, or making and selling things online.

TIP: Pretending you’re already making the payments on the mortgage you have in mind not only helps you save, it also shows you and your potential lenders that it’s affordable. Use an online mortgage payment calculator to work out your regular payments, subtract any rent or board you’re currently paying, and deposit the rest into a separate savings account.

Sell what you can: Start with your more valuable possessions and decide whether you could manage without them, or with a much cheaper version. Could you get by with a $5k car instead of that $20k one, for example? Even if it’s a while until you’ll need the deposit, it’ll let you test whether you can live without those possessions, plus you’ll earn interest on the savings in the meantime.

Check whether family can help: Your parents or another family member might be willing to help with your deposit. However, it does need to be a gift rather than a loan, and a lender will usually want a signed deed of gift as confirmation. Otherwise, a loan from family simply adds to your debts and reduces the amount you can borrow.

TIP: If it’s a loan from family that only has to be repaid when you sell the property, a lender might treat it as a gift.

How to reduce debt for DTI calculations

The most obvious way to do this is to repay as many debts as you can. That might mean selling or trading down on some of your more valuable possessions, such as a car, boat or e-bike.

“A less obvious option for reducing debt is to cancel any credit cards or overdraft facilities you have.  The maximum credit limits for these are typically counted as debt, even if you have nothing owing on them.” - Narelle Jakeway Financial Adviser, MTF

Example: Is it better to repay debt or have a bigger deposit?

Tanya and Lou have a $5,000 loan on their car, which they don’t want to sell. They’re wondering whether it’s better to repay the car loan from their house deposit savings or keep the debt and have a higher deposit.

Let’s say they’re buying a house valued at $1 million and, with help from a recent inheritance, they have a deposit of $200,000, which is 20%.  Here are some points they might need to consider.

If they use $5,000 of the deposit to repay the car loan:

• It won’t change their debt-to-income ratio because the smaller deposit would mean a mortgage that’s $5,000 higher, so their total debt doesn’t change\
• t would introduce LVR restrictions if they were buying an existing home, not a new-build. This could make pre-approval more difficult and incur a low-deposit/high-LVR fee or a higher interest rate
• Not repaying the extra $5,000 off the mortgage means the mortgage interest on it will keep getting charged year after year until they do

As you can see, it’s not a straightfoarward decision and it’s likely to depend on individual circumstances. Getting independent financial advice from a mortgage adviser can help ensure you weigh up all the relevant factors.

How to improve your income for DTI calculations

Everyone’s situation is different, but it often helps to discuss this with a financial specialist, such as an accountant or mortgage adviser. They’ll be aware of possible solutions for your situation and goals.

Talk to your employer

Sharing your plans with your employer and asking for raise (or when you might expect one) can help to provide more certainty about the future. Be prepared to talk about things like:

• How your contribution to the business has improved since your last pay review
• What other employers are offering for similar roles
• Relevant skills you have that aren’t being used in your current role, but could be applied in a higher paid one
• Extra responsibilities you’d be prepared to take on
• Why you’re keen to stay with the company, rather than move on to achieve your home ownership goals

Get career advice

Even if your employer has discussed how they see your career progressing within the organisation, it can help to get independent advice. Career counsellors or employment agencies specialising in your field can work with you to create a long-term plan based on your goals. They could also identify potential job opportunities, mentors or training programmes to help get things underway.

Apply for new jobs

Review your CV and look for roles that would give you the income you need. Let friends and family know about your plans, even if your preference is to earn more with your current employer. Many people get jobs through a friend who knows someone who’s looking for a new employee.

Consider having a boarder/flatmate

Renting a room can help to boost your income, at least until other opportunities come along. You’ll probably need a signed letter from your potential flatmate to say they intend to rent a room long-term for a particular amount once you have a property.

Buy a property with someone else

Another option is to consider buying a property in partnership with one or more other people. This allows you to combine your incomes and it can also help with the deposit. It’s important for each partner to get independent legal advice. You should also ask a lawyer to prepare a written contract or agreement that covers all possibilities, such as what happens when one person wants to sell up, and how maintenance and other expenses will be shared.

Self-employment can present challenges

Unless your income has been steady for several years, if you work for yourself a lender will probably only count a percentage of your annual income. Also, while side gigs can help you save a deposit, their income is usually too uncertain to be considered included in lenders’ DTI calculations.