There’s been quite a bit of media hype in New Zealand recently around the possible introduction of restrictions to lending criteria based on a buyer’s income. Called a debt to income ratio, the idea has been floated by the Reserve Bank of New Zealand in order to further address the supply and demand imbalance in our property market. Read on to find out how a debt to income ratio could affect you.
How will it work?
At this stage, a debt to income ratio is only an idea proposed by RBNZ. In its recent Financial Stability Report, the RBNZ mentions that “increasing housing supply is key and further efforts on a range of fronts should be considered to address the supply and demand imbalance”.
In its simplest form, a debt to income ratio means a buyer cannot borrow more than five times their gross annual income. To calculate your debt to income ratio, add up your monthly debt payments and divide them by your gross monthly income.
For many clients the rules around debt to income would have no impact, as banks already use a similar calculation to determine lending and, as they are covered by the Responsible Lending Code, are unable to lend money to anyone who cannot afford to service the debt. In fact, according to a survey of major banks undertaken by the Reserve Bank last year, 74% of first home buyers are below a debt to income ratio of five.
Does it work?
A debt to income ratio focuses on a household’s ability to repay loans, and promises an improvement in financial stability rather than just a tweak to house prices. But it’s not without its problems. Getting the ratio right is just one of these.
The Bank of England, for example, uses a debt to income ratio that limits mortgage lending to no more than 45% of income - that means that mortgage repayments cannot make up more than 45% of income. Applying this formula in New Zealand would lock most of our younger generation out of the market – despite future earning potential – while providing those at retirement age at the height of their earning potential with far more favourable options.
What about house prices?
Introducing a debt to income ratio will likely impact house sales and property prices in that it should aid in slowing down the market. But it’s still being seen as a stop-gap measure to a much bigger problem, which is the imbalance between supply and demand of property, particularly in Auckland.
Like many other interventions, introducing a debt to income ratio will impact people who want to buy a home and can afford the repayments, but simply don’t meet the income criteria required.
While it’s still early days, there have been a number of references made to the system used in the UK. After all, it makes sense to use a system that’s already working in other countries. The Reserve Bank of New Zealand will need to present a comprehensive assessment of the costs and benefits of applying a debt to income ratio to the Government.
If you’d like advice around planning your financial future, get in touch with our mortgage advisers.