Will the Debt-to-Income ratio changes throw your lending ability off balance?

The much-heralded debt to income ratio restrictions are finally here. What does this mean for New Zealand home buyers and investors?

According to economic data released on June 20, New Zealand’s GDP has increased, albeit only marginally by 0.2%. Although this doesn’t warrant popping the champagne corks just yet, it technically means NZ is no longer in recession. Homeowners are hoping the Reserve Bank’s reaction to the scourge of high inflation, which saw the hike in interest rates since October 2021, might become more relaxed in the future, with some suggestions that rates could even start dropping at the end of this year.

This is all generally positive news for Kiwis, but it also provides an interesting environment for the introduction of Debt-to-Income (DTI) restrictions – which were confirmed last month and come into effect from July 1st. They are intended to work as a complementary system with the existing Loan-to-Value Ratio (LVR) rules that are already in place, and will be eased simultaneously.

The Reserve Bank said new DTI restrictions will create limits on the amount of high-DTI lending that banks can make (i.e. where the borrower has taken on a high amount of debt relative to their gross, or pre-tax, income). The new settings allow banks to make 20% of new owner-occupier lending to borrowers with a DTI ratio over 6, and 20% of new investor lending to borrowers with a DTI ratio over 7.

The initiative was first consulted upon in 2021 during a dynamic period when demand was outstripping supply in the NZ housing market amidst an environment of historically low interest rates. The amount of debt a potential buyer could obtain was proving a major concern to financial and government authorities who were aware that a market correction was inevitable, not to mention to banks who were increasingly worried about the long-term implications of house hunters and property investors overextending themselves due to fear of missing out.

Those concerns amongst lenders would only become further entrenched when the market continued its post-lockdown overdrive and property prices soared to previously unimaginable and frankly unsustainable levels between 2021 and 2022, before finally moving into the current phase, which can only really be described as ‘flat’.

Many homeowners as a result have ended up with a property worth less than they paid for it, and in a large number of cases, people struggling to meet their mortgage payments due to the high cost of living. It’s tempting to ask whether these restrictions are even necessary when interest rates still remain high and job security is uncertain but we know from past experience that a new burst of energy in the residential housing market will come along eventually.

Back in January 2024 the Reserve Bank was already aware that their proposed mid-2024 activation of the DTI restrictions was probably going to occur in a period of slow growth, making the point – “we are proposing activating the tool now so that, when the housing market next enters a boom phase, the DTI restrictions will be in place to act as a guardrail against the build-up of high-DTI lending.”

The bank noted that first home buyers tend to borrow at lower DTI ratios so the new rules will have less impact on them and that the corresponding easing of LVR restrictions allowing banks to make 20% of owner-occupier lending to borrowers with an LVR greater than 80% might actually be helpful – which is very likely true as current conditions make saving a deposit harder than before especially with the Home Grant removed recently.

“Owner-occupiers tend to borrow at lower DTI ratios than investors. Also, as interest rates increase, owner-occupiers tend to experience financial stress at lower DTIs than investors,” they said. “Therefore, to reduce the systemic financial risk associated with high-DTI lending to owner-occupiers, we need to set the threshold lower for them than investors.”

Some investors will also benefit from easing of LVRs with banks now allowed to make 5% of investor lending to borrowers with an LVR greater than 70%. With an exemption for new builds, there will potentially be more incentive for property investors to venture into that particular territory – perhaps for the first time in their investing journey. Great news.

Deputy Governor of the Reserve Bank, Christian Hawkesby reiterated “while the LVR tool is aimed at improving the resilience of the financial system by reducing potential losses when households default on their mortgage, the DTI tool is aimed at reducing the probability of a systemic wave of households defaulting. We believe introducing DTI restrictions will reduce financial stability risks, support house price sustainability, and fill a gap that is not covered by existing policies,” he said.

Kayne Wahlstrom, from Properli believes that “being in such a high interest rate environment with interest rates in the 7s, banks are stress testing consumers at 9% which creates the safety barrier of borrowing capacity at present. Introducing the debt-to-income ratios right now should have little to no effect on the average person’s borrowing power however each situation requires careful analysis . We may see some effect on borrowing capacity when rates drop to historical averages, however there has been mentioned exemptions on certain property types i.e new builds”.

New regulations around lending are always a bit confusing when they first arrive and if you’re unsure about how the DTI restrictions are going to impact you, as a general homebuyer or as an investor, book a free 30 min consultation call with one of our Advisers – we can explain things clearly and help you to access your options, potentially even exploring ways in which these new changes can be a benefit.

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