A couple earns $120,000 a year combined. If their lender applies a debt-to-income limit of 6 times gross income, what is the most total debt they could hold?
Correct Answer
A) $720,000
Using a 6x income multiple, the couple could potentially borrow $120,000 × 6 = $720,000. However, this is subject to other lending criteria including debt-to-income ratios, expenses, and LVR restrictions which may reduce the actual amount approved.
Why This Is the Correct Answer
$120,000 × 6 = $720,000. That is a ceiling on total debt; the loan itself is also limited by the deposit (LVR) rules and the lender's own serviceability test.
Why the Other Options Are Wrong
Option B: $650,000
$650,000 is not produced by the 6 times multiple; it is simply a typical house price and says nothing about the debt limit.
Option C: $600,000
$600,000 is 5 times their income; the stated limit is 6 times.
Option D: $550,000
$550,000 is less than 5 times their income; 6 × $120,000 = $720,000.
Deep Analysis of This Finance Question
Since July 2024 the Reserve Bank's debt-to-income settings have limited how much owner-occupier lending banks can do above 6 times gross income (7 times for investors). The multiple sets the most total debt, including any existing loans. A buyer also has to meet the deposit rules and the lender's affordability test, so the loan actually approved is often lower than the ceiling.
Background Knowledge for Finance
A debt-to-income ratio in the Reserve Bank's sense is total debt divided by gross annual income. The settings let banks make only a limited share of new lending above the thresholds of 6 (owner-occupiers) and 7 (investors). Loan-to-value restrictions apply separately, and the lender must still be satisfied under the CCCFA that the borrower can repay without substantial hardship.
Memory Technique
Remember 'SIMPLE': Six times Income Means Potential Lending Estimate. Visualize income as building blocks - stack 6 blocks of $120,000 to reach $720,000. Think of it as 'income × 6 = lending height' like stacking money towers.
When you see income multiple questions, immediately identify the income amount and multiply by the given multiple. Remember that 6x is a common benchmark - visualize stacking 6 income blocks to get your answer quickly.
Exam Tip for Finance
For income multiple questions, identify the annual income and multiply by the stated multiple. Don't confuse this with property price or other figures in the question. Always use gross household income, not individual incomes separately.
Real World Application in Finance
Sarah and Mike, both teachers earning $60,000 each, visit your office wanting to buy a $650,000 home. Using the 6x income multiple, you can quickly calculate their maximum borrowing capacity as $720,000 ($120,000 × 6), showing they're within lending limits. However, you'd explain that final approval depends on their expenses, existing debts, and current LVR restrictions. This calculation helps them understand they can afford the property and might even consider slightly higher-priced options, giving them confidence in their house-hunting budget.
Common Mistakes to Avoid on Finance Questions
- •Confusing property price with borrowing capacity
- •Using individual income instead of combined household income
- •Applying wrong income multiple (5x instead of 6x)
Related Topics & Key Terms
Key Terms:
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When assessing a mortgage application, which factor is typically given the highest priority by New Zealand lenders?
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?
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- → A bank checks how much of a borrower's gross income would go on debt repayments. The borrower earns $80,000 a year, already pays $800 a month on other debts, and the new mortgage would cost $2,200 a month. What share of gross income would the repayments take?
- → Sarah earns $80,000 annually and wants to borrow $400,000. What is her debt-to-income ratio?
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- → Which of the following is NOT typically considered by banks when assessing lending criteria?
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- → Which type of mortgage allows borrowers to make additional payments that can be re-borrowed later?
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A couple with a combined income of $120,000 wants to buy their first home for $650,000. They have a 15% deposit. What is their LVR?