During a recent presentation to a group of property investors*, the topic of interest that sparked the most discussion and surprise was the looming imposition of restrictions on debt-to-income (DTI) ratios.
Changes seem almost certain to be imposed from about March 2024 and have become an even greater likelihood since the Reserve Bank’s (RBNZ) surprise move to loosen loan-to-value (LVR) ratio restrictions earlier than anticipated.
Here’s where things stand currently and some key unknowns:
We don’t know what the DTI limits will be. Will the RBNZ introduce a cap of seven times that of income, regardless of borrower type? Could there be exemptions introduced for new-builds? Is a speed limit system likely, as per the current LVR rules?
We do know the RBNZ already has permission to impose them
Banks will look at ‘all’ income and debt when calculating DTIs, incorporating existing loans as well as the potential new mortgage that’s being assessed
The rules would not apply to non-bank lenders
Impact on investors
Given investors’ risk profile and tendency for higher DTIs, the caps are expected to have a greater impact on these buyers more than others.
Although more relaxed LVR rules would tend to work in favour of investors, this may be cold comfort, after all, a smaller home deposit simply means a larger mortgage and higher DTI.
The RBNZ’s surprise announcement that LVR rules will be loosened on 1 June 2023 (subject to consultation) will allow 15% (currently 10%) of owner-occupiers to borrow with less than a 20% deposit, and 5% of investors to borrow with less than a 35% deposit (currently 40%).
It’s a surprising move given house prices may well still be above ‘sustainable levels’, and the implication of a lot of the RBNZ’s recent commentary has stated that LVRs might be loosened at the same time as DTIs were introduced (not nine months beforehand).
It’s important to note that high DTI lending has fallen sharply over the past 12-18 months, as house prices have fallen, incomes have risen, risk tolerance has reduced, and mortgage rates have increased, which has limited debt servicing levels.
For example, in 2021, 35-40% of investor lending was done at a DTI >7. That same figure has dropped to around 11% by the end of 2022. This is all to say the early adjustment in LVRs could reflect the substantial decline in the proportion of high DTI lending and all but confirms a change in DTIs is on the cards.
At a DTI of seven, for somebody who had an income of $100,000 and existing debt levels of say $350,000, in basic terms the rules would allow for an extra $350,000 of new debt (making total debt of $700,000).
For an investor looking at another purchase, the rental stream on that extra property would contribute to income and allow for some additional debt, how much will be decided by each specific lender.
However, that simple example illustrates the restraints DTIs could have on investors’ ability to expand their portfolio in the short to medium-term.
An extra $350,000 of debt may not go very far in today’s market. And DTIs also point to a lower assumption about the future long-term growth rate of house prices and therefore capital gains as price growth is more closely tied to income growth, which tends to average 3-4% per year.
Objective of tighter DTI rules
Just as the RBNZ has noted in its consultation too, the looming DTI rules are more about restraining the ‘next cycle’ for house prices and improving long-run financial stability, not so much about being a binding factor in the shorter term.
However, investors probably shouldn’t take too much comfort from that. This probable shift in the lending landscape is a major change and needs to be watched closely. The RBNZ’s modelling suggests that somebody who already has a large portfolio in the range of seven to 10 properties and therefore higher existing debt levels, may not be able to secure their next property for a decade after a DTI system has been imposed. Similarly, somebody with a small portfolio of one to two properties may not be able to add their next one for at least five years. The bottom line is income needs time to grow to service higher debt levels.
The natural response to the impending system changes could be for investors to bring forward their purchasing decisions and get into the market ahead of the DTIs. This in turn could contribute to a floor under current house price falls (for better or worse), alongside other factors such as flattening mortgage rates, rising net migration, and probable LVR loosening. Alternatively, as no strangers to risk, an increasing number of investors could also look to non-bank lenders to fund their future purchases.
But even if house prices stabilise soon, we don’t think they’re about to boom again, not least because DTIs will tend to dampen any future cycles, while mortgage rates are also likely to be ‘higher for longer’ over the next few years too.
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*A version of this article was originally published on the Auckland Property Investors Association website and the presentation was made to the monthly Canterbury Association’s meeting.
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