Debt-to-income (DTI) restrictions limit the amount of debt someone can have compared to their income. DTIs have been used for home loans in other countries for quite some time. Now the Reserve Bank is preparing for their introduction in New Zealand.
In this article we look at what the Reserve Bank has decided so far, when DTIs might be introduced and the expected impact on different people, from first home buyers to property investors.
What are debt-to-income (DTI) restrictions?
Debt-to-income restrictions consider someone’s total debt compared to their income from all sources. They’re normally expressed as a number and mainly used when assessing home loan applications.
For example, if you had a DTI restriction of 5 your total debt can be no more than five times your annual income. In addition to home loans, your total debt usually includes things like car loans, student loans, personal loans, overdraft facilities and credit card limits (whether you’re currently maxing them out or not).
What is the loan-to-income (LTI) ratio used overseas?
Several countries, including Ireland, have been using a similar idea to DTI ratio for quite a while – something called loan-to-income (LTI). LTI only considers the size of the loan, not the borrower’s total debt. The standard LTI restriction set by Ireland’s central bank is 4 for first home buyers and 3.5 for others. That means a first home buyer’s mortgage in Ireland can’t be more than four times their annual income. For joint buyers it’s their combined income. However, Ireland’s banks are allowed to use a higher LTI ratio for up to15% of their mortgages, provided they think the borrowers can afford the repayments.
What about New Zealand’s existing LVR limits?
In New Zealand we already have a tool known as loan-to-value ratio or LVR limit. This focuses on the size of your home loan compared to the property’s value.
The standard maximum LVR is 80%. It means your home loan can be up to 80% of the property’s value, so you’ll need a deposit that’s at least 20%. However, deposits of 10% (LVR of 90%) are possible for new-build homes. And deposits of 5% (LVR of 95%) are possible if you’re eligible for the low-income First Home Loan product, underwritten by Kāinga Ora. For property investors, the minimum deposits are 20% for a new-build property and 40% for an existing one.
Out of interest, the minimum standard deposit allowed in Ireland is 10% for first home buyers and others, and 30% for property investors.
LVR limits are expected to continue in New Zealand, alongside the new DTI restrictions, but with adjustments. The Reserve Bank recently announced that new LVR limits are likely to be 15% for loans with LVR above 80% for owner-occupiers and a 5% limit for loans with LVR above 65% for property investors.
When will DTI restrictions be introduced in New Zealand?
The Reserve Bank hasn’t announced when DTI limits will be introduced for registered banks; nor have they set a value. Instead, they’ve been consulting with home loan lenders on the proposed DTI framework. The consultation is now complete and the final framework has been published.
To give the banks time to update their processes and systems, the Reserve Bank has said DTI restrictions will not be introduced before March 2024. But they’ve made it clear this doesn’t imply a start date. They simply want to have everything ready, so they have another tool to use when required.
Why are DTI restrictions being added?
Although each lender is legally required to ensure a home loan is affordable and suitable for a borrower’s needs, they all use their own criteria for assessing this. We haven’t seen a huge number of mortgagee sales since interest rates recently increased, so it would seem the banks have been doing quite a good job. All the same, the Reserve Bank is keen to set some clear and consistent rules for all lenders.
DTI restrictions give the Reserve Bank another tool to use in their role of managing economic stability, particularly in the financial sector. It limits higher-risk home lending by linking credit availability to income growth, not just property values. This reduces the likelihood of a housing-related financial crisis. The finalised framework clarifies the rules for how personal debt will be treated, how things like business income will be calculated and how complex lending situations will be dealt with under DTI restrictions. This allows lenders to prepare.
How will DTI restrictions affect first home buyers?
The Reserve Bank is required to minimise the negative impact of their policies on first home buyers as much as possible. They believe DTI restrictions will have the least impact on first home buyers and lower income home owners. That’s because these groups typically have lower DTI ratios already.
In addition, the Reserve Bank has said the low-income First Home Loan product underwritten by Kāinga Ora will be exempt from DTI restrictions.
They may also allow some partial DTI exemptions for suitable applicants. These could include allowing loans with a higher DTI ratio for new-build properties, as well as allowing a certain percentage of a lender’s other home loans to have a higher DTI. This approach already exists with the loan-to-value ratios.
The Reserve Bank has also said the introduction of DTI restrictions may allow some easing of the LVR limits. This would help first home buyers, because saving up a deposit has become increasingly difficult with rising house prices.
How will DTI restrictions affect property investors?
The Reserve Bank believes DTI restrictions will affect property investors and higher-income property owners the most. That’s because these groups tend to have a high DTI ratio. They’ve also kept open the possibility of setting a different DTI ratio for different groups if required. This is currently the case with LVR restrictions.
During the consultation on DTI restrictions, the New Zealand Property Investors Federation (NZPIF) was concerned the restrictions would reduce rental property supply and, therefore, increase rents.
Despite the impact of DTI restrictions being greater for property investors, the Reserve Bank does not expect this to have an adverse effect on rental property supply. They point out that different DTI rates (exemptions) will be in place for new-build properties and loans for remediation of existing properties.
The Reserve Bank has also said that if investors are prevented from buying by DTI restrictions, more homes will be available for first home buyers, which will relieve some demand for rental properties. Finally, if DTI restrictions reduce average house prices, it will reduce the debt required to buy a rental property.