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Investors need to be watching the debt-to-income ratios discussion closely

At a recent presentation I gave to a group of property investors, the part that generated by far and away the most discussion and, dare I say, surprise/angst was around restrictions on debt-to-income (DTI) ratios – which seem almost certain to be imposed from about March next year.

As things stand:

  • We don’t know what the DTI limits will be – a cap of seven regardless of borrower type? Exemptions for new-builds? A speed limit system as per current LVR rules?
  • We do know though, that the RBNZ already has permission to impose them
  • Banks will look at ‘all’ income and debt in calculating the DTI – so this covers existing loans as well as the potential new mortgage that’s being assessed
  • Given their tendency for higher DTIs, the caps will tend to hamper investors more than other buyer groups, although the LVR rules also seem likely to be loosened at the same time
    • To be fair, this may be cold comfort – after all, the flip side of an investor putting in a smaller deposit is simply a larger mortgage and higher DTI!
  • The rules would not apply to non-bank lenders

What about an example? At a DTI of seven, for somebody with 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). Of course, for an investor looking at another purchase, the rental stream on that extra property would also bump up the income side of the equation and allow for some additional debt – albeit the banks themselves could still decide to apply a haircut.

However, that simple example does help to illustrate the strong restraint that DTIs will impose on the short to medium-term size of an investor’s portfolio – that is, 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/capital gains. After all, a DTI ties this more closely to income growth, which tends to average 3-4% per year.

At the same time, though, it’s also important to note that high DTI lending has already fallen sharply over the past 12-18 months, as house prices have fallen, incomes have risen, risk tolerance has reduced, and via higher mortgage rates limiting how much debt can be serviced. For example, in 2021, 35-40% of investor lending was done at a DTI >7. But now that’s dropped to only about 11%.

To my mind, then (and as the RBNZ has actually 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. After all, make no mistake, this probable shift in the lending landscape in less than a year’s time is a significant change and needs to be watched closely. For example, the RBNZ’s modelling suggests that somebody who already has a ‘large portfolio’ (and hence higher existing debt levels) may not be able to secure their next property until 10 years after a DTI system has been imposed – basically because income needs time to grow.

What might happen first? Clearly, the natural response would be for investors to get ahead of the DTIs (helping to bring current house price falls to an end) and look to non-bank lenders.

Kelvin Davidson

Kelvin Davidson is the Chief Economist of CoreLogic New Zealand.

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