Could Lending Get Harder?

At the end of January, the Reserve Bank announced that they had launched a consultation to activate debt to income (DTI) restrictions which are based around loan affordability and loosen loan to value ratios (LVR) which have been more about how far borrowers can leverage the equity in the properties used as security for residential lending.

There is some merit to what is being proposed. Borrowers are more likely to not pay their mortgages because of cashflow stress than equity being reduced, however I also believe there is serious overstep in applying it to investment lending as well as lending for borrowers own personal residences as in most cases overseas, they exempt lending for residential investment lending.

The initial DTI restrictions have been proposed as follows:

20% of their residential loans to owner-occupiers with a DTI greater than 6; and

20% of their residential loans to investors with a DTI greater than 7.

The proposed LVR changes are:

20% of owner-occupier lending to borrowers with an LVR greater than 80%; and

5% of investor lending to borrowers with an LVR greater than 70%.

So what does this all mean?

I’ll get onto what effect the multipliers of 6 for owner occupied lending or 7 for investors may have shortly but it is worth noting the 20% each that the banks will be allowed to do outside these categories at higher settings.

My initial thoughts are that this was very promising as this allows quite a bit of leeway. Now that I have had more time to think about this, I believe that this is likely to be the Reserve Bank playing politics as they will want to be quite gentle about bringing new regulation in where the new coalition Government and particularly David Seymour has already shown that they want to reduce red tape.

I think what is likely to happen over time is that they will tighten these percentages as and when they see fit. We have already seen this with how they have handled the LVR restrictions over the now almost 11 years they have been in place with moving the investment LVR’s to reduce demand and also the percentage of lending banks can do above a LVR of 80% (note that above they mention increasing this to 20%, it is currently 15% and had been reduced to 10% towards the back end of the COVID property boom and only relaxed June last year and which resulted in first home buyers to a large extend being locked out of the market because of this.

I think the Reserve Bank is looking to softly implement these now as initially they won’t have too much impact as interest rates are high and the test rates banks already use mean that for many borrowers they will already struggle to qualify. Over time as interest rates drop the test rates will also track down and there becomes a point where DTI’s will become the handbrake.

At KPM we have already seen how they can impact borrowers as both ASB and BNZ temporarily introduced them across 2020 and 2021.

The basic formula is:

Household gross earned income + scaled rental income = income which can be used for DTI’s (DTI Income)
DTI Income x 6 will be the maximum you can borrow for a personal home if you can’t access some of the amount the banks are allowed to do outside this.
DTI Income x 7 will be the maximum you can borrow for an investment property if you can’t access some of the amount the banks are allowed to do outside this.

A few comments on the above which are worth noting:

At present there can be quite large variances between the banks as to what percentage of rent they take. I wouldn’t be surprised to see this figure become standardised across all banks.
Note that all existing debt is taken into account and the maximum figures mentioned above will be after this debt is taken into consideration. This means for example that if a couple had $120k as overall gross household income and $20k of credit card limits then their borrowing capacity based on a DTI of 6 would be as follows:
- $120k x 6 = $720k
- $720k - $20k credit card limits
- $700k potential borrowing capacity
Note that gross household income (the income connected to the applicants earned income) is used, not net income. This makes no sense as if there are changes to personal tax rates it is not reflected in how this flows through to borrowing.
We see many clients who purchase investment properties initially to get onto the property ladder, and then later look to purchase their family home. As interest rates drop and the DTI rule becomes a larger hurdle than banks standard loan affordability process that they use currently I expect to see more people in this position where they can potentially buy another investment property because of the higher multiplier used but who may need to see investment property to the lower required multiplier for a personal residence.

There are exemptions

Besides the amounts allowed outside the standard multipliers there are other exemptions as well which are:

Existing lending – people will be able to refinance existing loans and not have DTI’s apply to this lending.
Construction lending – just as they did with the LVR rules, the Reserve Bank was always going to exclude this to encourage the supply of new property.
Bridging finance – this again is excluded with LVR’s so a continuation of this policy to enable liquidity in the market.
Kainga Ora First Home Loan scheme
Business loans – this is likely to be messy as many SME businesses in New Zealand leverage off residential property and the loan to value restrictions hindered these businesses’ ability to borrow although they were exempt.
Commercial property.

What should you do?

Get an understanding of how these changes may affect you. If you have existing mortgages or are looking to purchase over the next 12-24 months it is worth having an understanding so you can be in the best position possible. While these proposals have not been confirmed yet they are very likely to be what proceeds. If you would like us to do this for you Kris Pedersen Mortgages can assist with a no cost no obligation review.