Key mortgage benchmarks for risk – Explained

Commonly used mortgage benchmarks explained

I have been having conversations with borrowers around borrowing exposure since 2008.

I found clients did a lot of their own online research, and well-intended as it may have been, it does not offer them much guidance at all. They are usually seeking to clarify the amount of borrowing exposure they should consider have based on “expert recommended ratios”.

But are these expert recommendations from experts you have met with – or based on online research?

If an existing or ‘would-be’ borrower is looking to get an idea of a good loan amount for them – the last place to be relied upon is online. The first place they should go is a licensed broker or lender.

Home loan related news and commentary used to comprise of not much more than lender and RBA rate movements.

A lot has changed. The endless mediums used to engage people (readers/ listeners/ viewers/ subscribers) in housing and finance means there is a lot of analysis of high-level industry-specific numbers.

People are getting analysis of lender policy changes, mortgage stress level measures, interest rate buffers, interest only loan share and credit scores. Australians are even assumed to understand what the term serviceability means, as it relates to home loan eligibility.

Impressive if you get it.

Confusing if you don’t.

I started out in mortgage broking in 2008 and have seen seismic shifts in responsible licensing of mortgage brokers, lending laws and of course, lending policy.

There are many measures, ratios and statistics in home loan – world.

Let me address common mortgage benchmarks and explain a couple of them – 30% Repayment Ratio and Debt to income ratio (DTI).

Why are mortgage benchmarks used?

The mortgage benchmarks used in lending are an attempt to measure, among other things, risk.

Designed to monitor both the macro and micro-pictures, mortgage benchmarks are useful to inform and understand a home loan risk position for:

• Borrowers
• Lenders
• The Australian economy – and housing market

Who uses mortgage benchmarks?

The key groups that use mortgage benchmarks are:

• Government
• RBA
• ABS
• APRA
• Mortgage Industry
• Mortgage news
• Any news
• So-called expert commentators

Lenders
Like any business, lenders will set different benchmarks for the type of customer they want to attract.

Lenders also need to adhere to industry standards so they may report the different types of business they are doing to representative bodies. Over time and often because of unseen over-exposure, mortgage benchmark measures settled on.

Oversight and advisory
From the RBA setting monetary policy, the ABS publishing data insights and the government understanding and managing the economy – benchmarks are an important piece of the puzzle.

Why are we hearing so much about mortgage benchmarks?

Given the regular (often quarterly) public reporting of these mortgage benchmark measures – it seems everyone is interpreting and writing about these.

The result is a small amount of sensible reporting and big part—and somewhat frightening—headlines. I explore and challenge alarmist headlines in my article on mortgage stress.

So many mortgage measures

There can be such a thing as too much information.

• So many measures.
• So many recommendations from self-appointed experts.
• So much re-hashed content recommending “ideal” home loan amounts.

Borrowers do not need to know it all. They just need to have a handle on their goals and objectives. It could be something like:

“We want to buy a home to live in near transport and pay it off as quickly as possible.”

Then you meet with a mortgage broker or lender to work through your home loan eligibility.

I introduce readers to licensed mortgage brokers, so if this sounds like you follow the link below.

As a would-be borrower, there is a good chance going too deep with online research can leave you overwhelmed and confused.

Here are some of the measures reported on regularly by lenders. Many of which I have written about:

• Loan to value ratio (LVR)
• Home loan repayment ratio
• Debt to income (DTI) ratio
• Living expenses
• Credit score
• OO vs INV home loans
• Home loans on Principal and Interest (P&I) repayments
• Home loans on Interest Only (IO) repayments
• Type of loan product – Variable vs Fixed home loan
• Type of security/property
• Construction loans
• Lenders Mortgage Insurance (LMI)
• Self employed vs Employed borrowers
• Foreign currency loans

I am all for Australian borrowers being better informed, but this is a lot.

You can rest easy – there are licensed mortgage brokers I can introduce you to who can sift their way through the above.

Let’s get into the more useful benchmarks for non-bank people.

Lending policies vs Mortgage benchmarks

Lending Policy
Lender’s design policies to invite and target and certain type of borrower, home loan and everything in between. They are usually designed with benchmarks in consideration.

A key difference between lender policy and a benchmark is that loan applications that do not fit policy, usually end in a hard stop—a decline.

A good example is a loan application with an LVR of 99% –
If lending policy will not consider a home loan with a LVR over 95%, then the loan application will likely be declined.

The job of a mortgage brokers is to understand and filter lending polices to find a good fit for a borrower. I can introduce borrowers to licensed mortgage brokers to take you through your lending options.

Benchmark for loan applications
When it comes to a loan application, I see a mortgage benchmark as a guide around risk – a flag if you like (and not necessarily a red one). A higher risk application and invite closer inspection.

In my experience as a mortgage broker, a loan application can pass all the lender policies but still flag as a risk against a benchmark – like a high DTI.

Two key mortgage benchmarks unpacked

Oddly enough, the ratios that are commonly referenced online in ‘recommending a borrowing exposure’ are not typically ratios I have relied upon since becoming a licensed broker in 2008.

There is much more to proving loan eligibility than a ratio as I explain in my article on home loan affordability.

I will explain two ratios often referenced when trying to assess the stress levels in Australian borrowers. I compare these “standards” against real borrower ratios I have calculated and published? for borrowers I helped over a period from 2020 to 2022.

Benchmark – 30% repayment ratio
The 30% repayment ratio is an overused catch-all comparison of household incomes to home loan repayments.

It is expressed a percentage of the home loan repayments to the household income.

Repayment ratio = Household income ÷ Home loan repayment

That is, repayments for a mortgage should be no more than 30% of household income—a commonly quoted amount that is rarely referenced.

“…. too many refer to it as a ratio of authority.”

Some say use gross income, others net – some don’t say….

Let’s look at what the 30% repayment ratio means in a home loan example for a household with income of $200,000:

• A gross monthly income of $16,667
• The 30% Repayment Ratio puts the “recommended” repayment amount at $5,000/mth
• Based on a typical 2024 interest rate (RBA) of 6.28% the maximum loan amount would be $809,000

Be warned: the above calculation should not be applied to your circumstances. It can hardly be a recommendation – taking only a gross household income (ignoring expenses, goals and objectives) should not be the basis of a loan recommendation – still, too many refer to it as a ratio of authority.

It is hard to pinpoint where it started. It has been used for years – just picked up and run with.

In my article on mortgage stress I go into the what, where and why this measure should not be continually rammed down our throats as a mortgage-stress yardstick.

****I tested the 30% repayment ratio against my real client home loans.****

I analysed 73 groups of home loan applications I did for clients during 2020-22.
Many borrowers committed more than 30% of income to repayments.
82% of them should technically be in mortgage stress, given recent interest rate increases (in 2024). But they seem to be doing okay. Read about what was in these real borrower applications here.

Benchmark – Debt to Income ratio (DTI)
The other measure is Debt to Income (DTI) ratio. The proportion of all debt a household has as a multiple of income.

Lenders, guided by regulator APRA, have landed on a DTI of 6 as a tipping point for risk.

If I use the above example where there is an annual household income of $200,000, a DTI of 6 would put a loan of $1,200,000 in the higher risk basket.

Owing over six times does not mean a loan application will certainly be declined – I have seen these approved by lenders. There are usually specific features of a loan application causing a high DTI and as long is the reasons make sense, a lender can still entertain an approval.

For loan applications with DTI’s around 6, lenders might want to find out more about the overall financial position of the borrowers. They can look into the following.

• Income reliability:
  How reliant is the lender on overtime/bonus?
  Casual vs permanent
  Income stability – base, consistent business profits
  
• Home loan conduct
  What has conduct been like?
  
• Employment stability
  
• Nature of debt
  Home loan vs unsecured debt like credit cards and personal loans
  
• Debt reduction strategies
  Can they sell investment properties/shares?

In my experience as a broker, if a loan application makes sense, it usually results in a loan approval. So, while a DTI may register high against a DTI benchmark of 6 – it is not necessarily the end of the road for that home loan application.

Final word

The two mortgage benchmarks I explained are commented on, and referred to increasingly.

You should understand that making assumptions on you ideal borrowing amount based on these mortgage benchmarks is doing yourself a disservice.

Who should you listen to?
Licensed mortgage brokers write around three quarters of new home loans in the June 2024 quarter – so they must know what they are doing. Right?

Why?
Once reason could be that is a legal requirement that mortgage brokers act in the best interests of the borrower.

I can introduce you to a licenced broker to work things through.