Debt-to-income (DTI) rules restrict a borrower’s debt to a set multiple of their income. Various countries have employed DTIs for mortgage applications, because they can be an effective tool for ensuring loan affordability. Recently, the Reserve Bank has been gearing up to introduce DTIs in New Zealand.
This article covers the Reserve Bank’s recent announcements and the possible implementation date for DTIs. It also discusses the potential consequences for various groups of people, including first-time homeowners and residential real estate investors.
Debt-to-income (DTI) rules explained
When considering home loan applications, debt-to-income limits are taken into account by comparing a person’s overall debt to their income from all sources. The DTI limit is typically represented as a numerical value.
If your DTI limit is 6 your entire debt can be up to six times your yearly earnings, but no more. It’s worth noting that your overall debt refers to more than just home loans. It may also include student loans, car loans, personal loans, overdraft facilities and credit card limits, if you have them
Is it the same as the loan-to-income (LTI) ratio used overseas?
For a while now some other countries, including Ireland, have adopted a similar approach, which is known as loan-to-income (LTI) restrictions. Unlike DTI, LTI only uses the home loan amount, rather than your entire debt. The Irish central bank has established a standard LTI limit of 4 for first-time property buyers and 3.5 for other buyers. So, a first home buyer’s mortgage in Ireland is limited to four times their yearly income. When more than one person is applying for the home loan, the limit is based on their collective income. But there is some flexibility. Irish banks can use a greater LTI limit for up to 15% of their mortgages if they’re convinced the borrowers can handle the repayments.
How will DTI rules affect our current LVR restrictions?
In New Zealand, we currently use a tool called the loan-to-value ratio (LVR) limit, which compares your home loan to the property’s value.
- The standard maximum LVR is set at 80%, which means your home loan can be up to 80% of the property’s value and your deposit must be 20% or more.
- For new-build homes, deposits can be as low as 10% (LVR of 90%).
- Kāinga Ora‘s low-income First Home Loan product allows for a 5% deposit (LVR of 95%).
- Residential property investors must have minimum deposits of 20% for a new-build property and 40% for an existing one.
Why do we need the DTI rules?
Every lender has a legal obligation to ensure that a home loan is affordable and suitable for a borrower’s needs. However, they all use their own standards to evaluate this. Although interest rates have recently increased, there haven’t been a significant number of mortgagee sales, indicating that the banks have done a decent job. Nonetheless, the Reserve Bank wants to establish clear and uniform requirements for all lenders.
DTI rules provide the Reserve Bank with an additional instrument to manage economic stability, particularly in the financial sector. They restrict higher-risk lending by tying credit availability to income growth, rather than just property values. This lowers the chances of a housing-related financial crisis. The finalised framework defines how personal debt will be handled, how to calculate aspects like business income, and how complicated lending scenarios will be dealt with under the DTI rules. This allows lenders to be prepared.
When are the DTI rules starting in New Zealand?
The introduction date for DTI limits for registered banks has not been officially announced by the Reserve Bank, and a DTI ratio has not yet been set. Instead, the Reserve Bank has been in talks with home loan lenders about the proposed DTI framework. The consultation process has ended and the final framework has been released.
The Reserve Bank has stated that the DTI rules will not be implemented before March 2024, to allow banks sufficient time to update their processes and systems. It’s important to note, however, that this does not signify a start date. The Reserve Bank’s goal is to have everything prepared and ready, so they can deploy DTI when it’s needed.
How will first home buyers be affected by the DTI rules?
The Reserve Bank must minimise the adverse effects of their policies on first-time home buyers, to the best of their ability. They say that DTI restrictions will have minimal consequences for these buyers and low-income homeowners, because these groups typically have lower DTI ratios already.
What’s more, the Reserve Bank announced that the low-income First Home Loan product, backed by Kāinga Ora, will not be subject to the DTI rules.
The bank may also consider granting partial DTI exemptions to suitable applicants. These exemptions could involve allowing loans with a higher DTI ratio for new-build properties and a specific percentage of a lender’s other home loans to have a higher DTI. This approach is already in place for loan-to-value ratios.
The Reserve Bank also indicated that the introduction of DTI rules may lead to some relaxation of the LVR limits. This will benefit first-time home buyers, since saving for a deposit has become increasingly difficult due to escalating house prices.
How will property investors be affected by the DTI rules?
The Reserve Bank anticipates that property investors and high-income property owners will be most affected by the DTI rules, due to the typically higher DTI ratios of these groups. The bank has not ruled out the possibility of implementing different DTI ratios for different groups if necessary, similar to the current LVR restrictions.
During the consultation process for DTI rules, the New Zealand Property Investors Federation expressed concerns that these limitations would decrease the supply of rental properties and subsequently increase rents.
Despite the fact that DTI restrictions are likely to impact property investors more significantly, the Reserve Bank does not believe that this will have a negative impact on the supply of rental properties. They note that exemptions for new-build properties and loans for the remediation of existing properties will have different DTI rates in place.
Additionally, the Reserve Bank has stated that if DTI rules prevent investors from purchasing properties, more homes will become available for first-time buyers, thereby reducing the demand for rental properties. Lastly, if DTI rules lead to a reduction in average house prices, this will lower the debt required to purchase rental properties.
