The Reserve Bank is looking to revamp its rules for retail bank mortgage lending and plans to bring in debt-to-income ratio (DTI) restrictions mid-way through 2024. But what is debt to income ratio, and how can it affect me as a first home buyer, homeowner or property investor?
In this article, we dive into understanding the debt-to-income ratios proposing to be bought in by the Reserve Bank, why these restrictions are being brought in, and will answer your most pressing/common questions on how it may affect your current situation.
Understanding the Debt-to-Income Ratio
Before dissecting the recent changes, it’s crucial to establish a good understanding of what debt to income ratio is. At its core, the debt-to-income (DTI) ratio measures the proportion of an individual’s or household’s total debt payments (i.e. mortgage, rent, credit cards, loans etc.) relative to their total gross yearly income (before tax). The debt-to-income ratio metric serves as a tool for lenders, regulators, and borrowers alike by providing insights into affordability and debt servicing capabilities of an individual or household.
Why Debt to Income Ratio Restrictions are Looking to be Implemented
The rationale behind these regulations stems from concerns about escalating property prices, increasing levels of household debt, and the potential risks posed by excessive borrowing for both individuals and households. The implementation of the debt-to-income ratio restrictions will aim to keep house prices in check over the long term. House prices have typically grown 7-8% each year, which is almost double the 4.35% average growth of household income per year. The DTI rules aim to tie house prices much more closely to income in the near future and ensure that homeowners and prospective homeowners are not getting in over their heads; still being able to service their mortgage as well as other debts they may have.
So if it’s a good thing, why are New Zealanders getting so up in arms about it?
The proposed DTI restrictions will allow first home buyers and homeowners to borrow 6 times their gross annual income and property investors to borrow 7 times their gross annual income/any income earned from their current rental properties. In addition to these DTI restrictions, the regulator is proposing to banks that no more than 20% of the value of the mortgages they issue owner-occupiers can go to borrowers seeking debt worth more than 6 times their gross annual income, and for investors, 7 times their gross annual income.
Debt-to-income ratio example for homeowners and prospective homeowners:
Debt-to-Income Ratio example for property investors:
The main point of contention many first home buyers, homeowners, and property investors alike have with these proposed DTI regulations is that this doesn’t sound like an awful lot!
In the exemplars above, you can see that you don’t have to have a lot of debt to end up in the red zone i.e. not allowed to borrow any more money before you pay down your existing debts, this could bring homeowners and property investors investment plans to a grinding halt, as they won’t be able to scale as fast as they once were.
Changes in LVR Restrictions
However, it’s not all doom and gloom; in addition to these DTI restrictions, the Reserve Bank want to ease loan-to-value ratio (LVR) restrictions. It’s proposing to tell banks that no more than 5% of their housing loans to investors can go to borrowers with deposits of less than 30%. Currently, most investors need deposits of at least 35% to invest. For owner-occupiers, the Reserve Bank is proposing to cap the value of loans to borrowers with deposits of less than 20% at 20% – increasing the current cap by 5% to provide a bit more leeway to get home loan applications over the line for some New Zealanders.
Impact on First Home Buyers:
The Reserve Bank has stated that the new debt-to-income ratios are mainly set in place for property investors who are living outside of their means when it comes to debt, and higher income owner occupiers who borrow at higher debt-to-income ratios. The Reserve Bank even went as far as saying that first home buyers could potentially benefit from this rule change as prospective home buyers and lower income homeowners generally borrow at lower debt-to-income ratios.
However, there are always instances in which regulations will still be applied, and may negatively impact your situation. Here are a few examples:
- If you’re an individual, a family on one income, or are on a low combined income as a couple
If you’re an individual, are a family on a single income, or are a couple on a low combined income and are looking to buy a house, your lending power will be less. This doesn’t mean your situation is hopeless, as you may fall into the 20% bracket who the banks can lend to over the 6x gross income limit. Some analysts fear that the proposed DTI limits may disproportionately affect young and low-income individuals, further widening the gap between those who can afford homeownership and those who cannot. As policymakers navigate through this issue, the ultimate impact of these proposed changes remains to be seen, with potential implications for both the housing market’s stability and social equity.
2. If you live in an expensive region
If you’re wanting to purchase a house in a more expensive region, say Auckland, for example, you’d have to have an average combined household gross income of $172,000 to buy an average-priced house. For the average New Zealand family, this is seriously overreaching as the average gross income for a household is around $115,000. This is one of the main concerns being voiced to the Reserve Bank on the proposed restrictions. Tighter lending standards may demand larger down payments or force buyers to settle for less expensive properties, potentially worsening affordability issues in already heated housing markets.
Impact on Homeowners
For homeowners, the implications of potential DTI restrictions will come into play when one of three things happens:
- You’re looking to upgrade to a nicer, bigger house
This is the time to bring out the DTI calculator and calculate how much you’re needing to borrow vs. how much you’re allowed to borrow, based off of your gross income. This is particularly important if you’re now on just one income. Is the new house worth twice the price of your current home? If this is the case and your incomes are the same or you’ve now dropped down to one income, you may find yourself in a sticky situation.
2. You’re looking to renovate your current home by topping up your mortgage
When you’re wanting to top up your mortgage or take out an additional loan to renovate your current home, this may be when the DTI regulations come out and bite you in the butt. How much are the renovations going to cost? What is the end goal of the renovations and how much value will they add to your current home? Are you currently just on one income? Ensure you look at both sides of the coin before forking out 25% of your DTI allowance.
3. When you’re looking to invest in property
The imposition of DTI restrictions could restrict your ability to leverage property assets for wealth accumulation or financial flexibility, impacting your long-term financial objectives and slowing down your progress. If you’re thinking about investing in property, this is the time to bring out the DTI calculator and calculate how much you’re needing to borrow vs. how much you’re allowed to borrow, based off of your gross income and current equity in your owner-occupied property.
Impact on Property Investors:
Property investors will be the most impacted by the proposed debt to income changes. Particularly if:
- If you have a huge amount of investment debt
Brace yourselves – it may be a bumpy ride! If you have a large amount of investment debt in old builds and are already over the threshold of debt-to-income i.e. have borrowed 7x your gross annual income/rental income combined and above this, it will most likely be quite difficult to keep on investing unless you’re investing in new builds, which are exempt from debt-to-income ratios.
2. You’re wanting to rapidly invest in property
If you’re flipping houses or are accumulating properties rapidly, the new restrictions may seriously slow down your endeavors, particularly if you’re in a large amount of debt from owning several investment properties as you may have to wait for your equity position to improve before you’re able to invest again.
The proposed changes to New Zealand’s Debt-to-Income ratio regulations highlight the commitment to encouraging a resilient and sustainable housing market. The queries and criticisms voiced by the public, banks, and economists highlight the need for further research into how to make the debt-to-income restrictions fair and housing accessible to all New Zealanders. While these changes may pose challenges for homeowners and property investors in the short term, they also present opportunities to promote responsible borrowing practices, enhance financial stability, and mitigate systemic risks.
If you’re wanting some advice on how to circumvent the new DTI regulations or are wanting to set some things up now before the DTI restrictions come into play, book a 15-minute mortgage advice consult with us now by clicking the link below.
