A bank is calculating a borrower's debt-to-income ratio for mortgage approval. The borrower earns $80,000 annually and has existing debt commitments of $800 per month. They want a mortgage requiring monthly payments of $2,200. What is their total debt-to-income ratio?
Correct Answer
C) 45%
Total monthly debt payments are $3,000 ($800 existing + $2,200 mortgage). Annual debt payments are $36,000. The debt-to-income ratio is $36,000 ÷ $80,000 = 45%. This exceeds typical bank comfort levels of 30-40%, making approval challenging under standard lending criteria.
Why This Is the Correct Answer
Option C (45%) correctly calculates the total debt-to-income ratio. The borrower's total monthly debt obligations are $3,000 ($800 existing debt + $2,200 proposed mortgage payment). Converting to annual terms: $3,000 × 12 = $36,000. The DTI ratio is calculated as total annual debt payments divided by gross annual income: $36,000 ÷ $80,000 = 0.45 or 45%. This calculation follows standard banking methodology for assessing borrower capacity under responsible lending criteria.
Why the Other Options Are Wrong
Option A: 33%
33% incorrectly calculates the ratio by likely only considering the existing debt ($800 × 12 = $9,600) plus a portion of the mortgage payment, or using an incorrect denominator. This fails to include the full proposed mortgage payment of $2,200 monthly in the total debt calculation.
Option B: 39%
39% represents an incomplete calculation that may have included most but not all debt components, or used an incorrect methodology. This could result from calculation errors in converting monthly to annual figures or excluding part of the existing or proposed debt obligations.
Option D: 52%
52% overcalculates the ratio, possibly by double-counting debt components or using incorrect figures. This percentage would represent an even more concerning debt level that would almost certainly result in loan decline under standard lending criteria in New Zealand.
Deep Analysis of This Finance Question
Debt-to-income ratio (DTI) is a fundamental metric banks use to assess borrower creditworthiness and loan affordability. This calculation determines what percentage of a borrower's gross annual income goes toward debt servicing. In New Zealand's lending environment, banks typically prefer DTI ratios below 40%, though this varies by lender and borrower circumstances. The calculation requires converting all debt payments to the same timeframe - here, monthly payments totaling $3,000 ($800 existing + $2,200 proposed mortgage) equate to $36,000 annually. Divided by the $80,000 annual income gives 45%. This exceeds most banks' comfort zones and would likely trigger additional scrutiny under responsible lending obligations. Understanding DTI calculations is crucial for real estate agents as it directly impacts client pre-approval prospects and property affordability assessments.
Background Knowledge for Finance
Debt-to-income ratio measures the percentage of gross income required to service all debt obligations. New Zealand banks typically prefer DTI ratios below 40% for residential mortgages, though this varies by institution and borrower profile. The Reserve Bank of New Zealand has implemented DTI restrictions as macroprudential tools. Calculations include all recurring debt payments: mortgages, personal loans, credit cards, hire purchase agreements, and other regular commitments. The ratio helps lenders assess affordability and compliance with responsible lending obligations under the Credit Contracts and Consumer Finance Act 2003.
Memory Technique
Remember DEBT: Divide Everything By Total income. Take all monthly debt payments, multiply by 12 for annual amount, then divide by annual gross income. Think of it as 'Every dollar of DEBT needs to be measured against Total income.'
When you see DTI questions, immediately identify all debt components, convert to annual figures using the DEBT formula, then divide by annual income. This systematic approach prevents missing debt components or calculation errors.
Exam Tip for Finance
Always convert all debt payments to the same timeframe (monthly or annual) before calculating. Include ALL debt obligations, not just the proposed mortgage. Double-check your arithmetic by working backwards from your answer.
Real World Application in Finance
A real estate agent is working with first-home buyers earning $80,000 combined income. They have a car loan ($400/month) and credit card payments ($400/month). They're looking at properties requiring $2,200 monthly mortgage payments. The agent calculates their 45% DTI ratio and advises them this exceeds most banks' 40% threshold. The agent suggests either increasing their deposit to reduce the mortgage payment, paying down existing debt first, or looking at lower-priced properties to improve their approval chances.
Common Mistakes to Avoid on Finance Questions
- •Forgetting to include existing debt in the calculation
- •Mixing monthly and annual figures without proper conversion
- •Only calculating the mortgage DTI instead of total DTI
Related Topics & Key Terms
Key Terms:
More Finance Questions
What is the current standard LVR (Loan-to-Value Ratio) restriction for owner-occupier residential property purchases in New Zealand?
What is the minimum amount a first home buyer can withdraw from their KiwiSaver account for a house deposit?
Which type of mortgage has an interest rate that remains unchanged for the entire loan term?
What is the maximum KiwiSaver HomeStart grant available to a couple purchasing their first home?
Sarah and Tom are first home buyers with a combined annual income of $140,000. They have found a house for $750,000 and have a 15% deposit. What additional challenge might they face under current lending restrictions?
- → What is a key advantage of a revolving credit mortgage facility?
- → When assessing a mortgage application, which factor is typically given the highest priority by New Zealand lenders?
- → Under the Responsible Lending Code, what must lenders verify before approving a mortgage?
- → A property investor wants to purchase a $900,000 rental property. Under current RBNZ LVR restrictions, what is the minimum deposit they would typically need to provide?
- → James has been contributing to KiwiSaver for 4 years and wants to withdraw funds for his first home. His KiwiSaver balance is $45,000, but $15,000 consists of government contributions and employer matching. What is the maximum he can withdraw for his house deposit?
- → What does LVR stand for in New Zealand mortgage lending?
- → Under current RBNZ LVR restrictions, what is the typical maximum LVR for owner-occupier first home buyers?
- → What is the minimum age requirement for accessing KiwiSaver funds for a first home purchase?
- → Which type of mortgage allows borrowers to make additional payments without penalty and redraw those funds when needed?
- → Sarah has been a KiwiSaver member for 4 years and wants to withdraw funds for her first home. Her KiwiSaver balance is $45,000. What is the maximum amount she can typically withdraw?
People Also Study
Property Law & Legislation
130 questions
Agency Practice
130 questions
Sale & Purchase Process
130 questions
Professional Conduct & Ethics
110 questions