Why you need to know about Debt to income ratio (DTI)

Crown Money, where we show you how to pay your home loan off in up to half the time of a normal bank loan. Welcome to the podcast. I'm Jessie Edge and I'm joined by Scott Parry. How you going?

Very well, very well. We're at the end of the tunnel. The light is here.

At the end of what tunnel?

Sorry, COVID Lockdown tunnels are tough. Few years there, to be honest. So, yeah, I'm out and about.

You're out and about, you're feeling good, seeing friends. It's gone from nothing to everything, though, like quite.

From existing to living. Yeah.

Which is great, but it's kind of intense.

Yeah. It's obviously when you let out of prison, it takes a while to reintegrate back into society, so it's going to take us a while.

What do you think you missed the most?

What do I miss the most about lockdown?

No, what do you think you missed the most whilst you were in lockdown?

To be honest, for the first time in my life, I actually thought it'd be really good to be able to go to a gym.

I was going to say something, but.

I mean, I haven't been to a gym in 40 years, so something where I felt, you know what? I really feel like I could go to a gym with all this spare time.

Yeah, I love that. Actually, you touched on a good subject. There it is. Your 40th, wasn't it?

Yes, yes, it was a. Certainly not the party. I anticipated all the shindig. It was a much quieter fair. But nevertheless, it was an enjoyable celebration and I think I'll bank the proper party for maybe next year when things are a little bit more open.

Yeah, that's something. What do you think is your top two lessons in your 40 years?

Top two lessons. Wow. I wrote a list of the top 40 things I'm proud of in the last 40 years and I think from that list, top two things I've learned are really that time is my most precious currency.

Oh, yeah, good one.

And I'll do anything to buy that time back. Obviously, lockdown. I felt robbed of time. And the other thing was it's really the simple things in life which I've actually got the most amount of enjoyment out of. Wow. The like having a kid and just being able to sit with him, go on a bike, ride with him. Such a simple thing. But I just have found that's where I'm happiest is when I'm just doing simple things which are usually free. Which is another sort of big insight. I used to think that the more money you make, the more you can spend, the more happy you're going to be, slash enjoyment factor. But that certainly hasn't been the case at all. That whole cost per unit of fun has been phenomenal.

Yeah, that's such an incredible perspective, isn't it? Realizing it doesn't cost money to have a good time. Do you think that's because we've gotten older and we do enjoy simpler things or, or.

Yeah, I think also because I've already done in my eyes everything I've always wanted to be able to do. So I really am just enjoying the stopping, I'm enjoying the slowing down, I'm enjoying the. Just the real simple things in life which are just giving me a huge amount of enjoyment at the moment.

Little lockdown, silver lining.

Hey, there's been many silver linings for lockdown, but that would definitely be one of them is just the realization. I think a lot of clients come through this as well where you are spending just so much money on entertainment like because the norm and it has been the pace you've always moved at to when you stop spending money on entertainment, all of a sudden it actually starts to go, well, I actually don't need that so regularly in my life.

Yeah, absolutely. Sorry, I've got a couple of notifications going on. I'm just going to turn that.

Yeah, certainly do a little annoying sounds.

What we're going to do.

Let's questions coming in from the audience, Questions coming from the audience.

Let's segue away from conversation about your 40th and talk about things you've learned. I think, you know, let's move back into the finance industry and there are a lot of changes going on at the moment that are going to hugely impact people and quite. I don't know people, a lot of people don't know about it or haven't kind of realized the significance. So yeah, let's talk about that today.

The debt to income ratio DTI not a sexual transmitted disease by any stretch of the imagination. It is debt to income ratio. Yeah. This is fascinating and I think where we're so privileged, Jess is being able to work in the jobs that we work in, where we're at the coal face, we see everything before it filters through to the economy. And this is a huge flag for me. I mean when, when I see flags and I say, okay, that's interesting that what effects that going to have downstream? This I see is a huge effect downstream. And so when we say debt to income ratio, what actually is that Jess, what is a debt to income ratio?

Well, it's pretty simple. It's just how much debt do you have compared to how much your income is? And so what they're saying now, instead of saying, okay, you can borrow as much as you can as you want to based on a servicing calculator, they're now saying, no, we're going to limit it to six times your income. So if your income is 100 grand, the maximum you can borrow is 600 grand, which for a lot of people is not a lot nowadays when you're trying to buy properties that are in the millions. So.

Yeah, yeah. And also when you are looking at, let's say you, that person, 100 grand, you're like, okay, well, I can borrow 600,000. But if you put rental income into that, then you also get to include the rental income in your debt to income ratio. So let's say you bought an investment, or let's say you're going to get 30 grand a year in rent, where you also get six times that, 30 grand a year, which is 180,000 on top of the 1,000 you can borrow. Yeah. So it's your total income, your gross salary plus your rental income times, I think seven is probably more accurate. I think most of the lenders are sort of coming in at 6 to 7. There's one or two lenders that come in at sort of 8. And we've got one lender which sort of still hasn't come on board yet. And they're still running with the old world calculation.

So it'll be soon, though. It'll definitely be soon.

2022, this is happening. What does that mean for us as homeowners, investors, borrowers? What it really means is I've always said that the day banks tighten credit, which is exactly what's just happened, is the day that people can't afford to borrow as much, and if they can't afford to borrow as much, that means they can't afford to offer as much. When they go to put down offers on properties, if they can't afford to offer as much, that means that those prices won't be increasing as much and thereby people can't borrow as much. They can't offer as much, prices can't go up as much. That is, in my eyes, very close to a peak in the market because people's borrowing capacities last month, prime example, had a client who I did a borrowing capacity for last month based on their incomes, could borrow a million dollars for investments, so they could go and buy A million dollar investment property did the same calculation this month with the new DTI rules. 600 grand, their borrowing capacity reduced 400 grand.

That's a problem.

And so that is, I mean it's a huge property. So if that's just that client, imagine all the people in Australia who are going to be sort of coming up against these headwinds. So yeah, for me this has been the first move where I also see rates going up next year. So you, you combine those together where people's borrowing capacities have been reduced, their rate increases, plus they've also increased the rate they assess your loans at those three for me. Wow. I really don't see the growth that we've had happening at all next year.

Yeah. Do you actually think the property market will drop or do you think just that the growth will slow?

I think the growth will slow and then it'll depend on how quickly they react to that slowing growth. Because that's what they're trying to do is just slow the property market. That's why they've done this is because it's white hot. It's the hottest I've seen in 20 years.

It's crazy, isn't it? These last months is just bananas and it's like we've just been in a pandemic.

People come on and everyone that we know owns property so they're all beneficiaries of that, which is great. And every, I've never seen every suburb in Australia go up.

It totally reminds me of like the pre GFC kind of times where everybody was making money in their slate. Like it was amazing. It was such good times. You never had to worry about your property not appreciating in value. Just, it just was what happened. And then all of a sudden GFC hit and everyone realized, oh, hang on a second, the property market isn't as guaranteed as we all think it is.

I think that was a wake up call big time. So there's cycles out of a 10 year cycle, property will go up for three years, it will go down for two years, it will go sideways for five. So I think we've had a good. But I don't think it's going to crash to a point where it's going to drop 50% because the demand's always there and react. I mean the government knows that people feel richer and happier when their house price is going up. And if you are trying to win an election that election year, you want to make sure people's houses are going up because when they're coming down in value because people every 3.9 years will refinance now, refinance, usually for a cheaper rate, which means they reset the loan back to a 30 year term. Massive fail. They'll refinance to do a renovation, consolidate some debt. When you're trying to refinance at the moment, you've got so much more equity than what you envisage. So you can do all those things. When the prices start coming down, you don't have that equity and you can't consolidate that debt. So it just has that sort of ripple effect where all of a sudden you carry that extra credit card or car loan that you normally would have consolidated into your equity, where you no longer can do that. So that's where I sort of seen the years ahead. And that's why I am certainly not as bullish on the property growth as I was 60 days ago.

Yeah, absolutely. I think, I think it's important to understand why this has been brought in as well and how it is actually. I mean, as annoying as it is and frustrating and limiting as it is, it is there for a reason. And it's about, you know, minimizing people's exposure to risk. And so, you know, the more debt you have, the more risky it is. And banks are foreseeing or, you know, the RBA is foreseeing what's going to come in the future. And they're saying if interest rates are so ridiculously low at the moment, we have been lulled into a false sense of security and we are very comfortable with our repayments. But as soon as repayments start going up, interest rates start going up. That massively affects your net cash flow each month. So what they're trying to do is say, hang on a second, we've got to cap this, we've got to limit the amount people can borrow because in a couple of years time, interest rates are not going to be as low as they are now. They're going to be so hugely exposed. And that's going to put a lot of pressure on Australian households. So, look, I, you know, whilst this has a huge impact, I do see the positives in it. Like it's there for a reason. And I think that's important for people to keep in mind.

Yeah, they had to do something. I mean, this property market is literally parabolic vertical and it's just, it's unhealthy for anything to be growing that quickly, especially for a lot of these first homeowners. You know, you're like, I feel sorry for them trying to Save a deposit and they think okay, I've only got to say 50 grand to get into my first home. So yeah, when you got a house with 750 and you thought you were getting into the 500,000 mark, it means you've got to really get another 50% deposit. And so it just keeps getting further and further away from these first home buyers. So now everyone that we're speaking to as a first time buyer is really relying on their parents to become guarantors. And so how that works is I got Mum and dad, they've had capital growth, they've had the house for 10, 20 years. And so the banks will look at the equity in their house and they'll say okay, we can see your mom and dad have got equity, let's pretend that's your deposit, we'll loan you 100% of the purchase price and then mom and dad are sort of going to be in the background as a sort of deposit in the bank size. And so I think that's going to be the norm for.

And that was a good way out. But that still doesn't get them out of the whole DTI issue. Like you are still borrowing it under your own. The only way would be if the parents actually borrowed the money themselves and then gifted it to the kids which is just really getting really difficult. Got really tricky. So yeah, it is, it is. They're getting first time buyers are going to get hit twice now, which is a bit unfortunate.

Yeah, it's, it's something where if you're in you're happy but for those who aren't in yet it's, it's going to be pretty tough going forward. So yeah, I think there's definitely banks a crave where I just heard of a, a new 40 year home loan.

Oh wow, very interesting. What are your thoughts on that?

I think it's horrific. I mean all of our clients are out of debt in under 15 years. So to try and put a 40 year home loan in front of someone, I get it, like obviously your repayment is going to be less, it's going to be more manageable. But do you know much more money the banks make in interest that extra 10 years. So I don't like debt, I don't like bad debt, I like having Australians pay off the house, live a debt free life with no mortgage repayments, all their income to spend on lifestyle experiences with their family or, or even investing. And so just to have someone in debt for 40 years for me is everything I'm against.

Yeah, absolutely. I think that leads us into the next part where we say, what. What can we do to combat the whole DTI issue? Or. Or what's coming? You know, what, what should people be doing to prepare?

So there are only two ways to increase your borrowing capacity. One is to earn more. That means get pay rises, have a higher income, change jobs, whatever it may be. The other is to actually reduce debt. And so we all know that Crown money is about reducing debt, paying off your house in half the time. And so the faster you pay down your home, the more equity you've got, the lower your debt is. And then when banks go to do your borrowing capacity, they look at, okay, well, you owe $200,000 on your home loan last year. Now you owe 150. So you can borrow an extra 50,000, 75,000 probably to invest. And so from that perspective, I think you got to pay down debt. And whilst you've got low rates, I think, and especially during COVID we had so many clients build up amazing buffers because their entertainment expenses were gone.

Yeah. How incredible was that?

Like, huge savings rates, huge savings rate. So when we've got clients saving 75% of their salary, which is unique. Heard of the Chinese traditionally save 50% of their salary. We know how good a savior they are. So to have someone saving 75% of their salary is like freakish. Our average savings rate at crown is 25%. I believe the average savings rate in Australia is around about 9%. So, yeah, I mean, all of our clients are doing so well. They've got a money management system which is proven and tested. It works, and it works at helping get out of bad debt as quickly as possible. Credit equity in their home, they can use that to put towards investments and setting themselves up for a super comfortable retirement.

Awesome. I think this is all really great information, so thank you, Scott. I think, you know, if anybody wants to reach out and have a chat about what their borrowing capacity is now under these new rules, or wants to, you know, talk about their own strategy with their home loans or potential investment properties, just reach out to us. But yeah, thanks again, Scott. We'll chat soon.

Thanks, Jess. Have a great day. Sam.