Earlier in June 2017, the Reserve Bank released a consultation paper on setting restrictions that would limit the amount buyers could borrow for their mortgage based on their income. If these measures are deployed, it’s estimated around 2,000 owner-occupiers and 9,000 investors a year would effectively be cut out of the property market. Would this solve New Zealand’s housing problem? Read on to find out more.
Weighing up the options
The Reserve Bank is considering deploying debt-to-income measures that would see home buyers being limited to a mortgage of five times their household income. Borrowers who already have large mortgages compared to their incomes could face financial stress should interest rates rise, with many not having enough left over to cover essential household spending once their loan has been paid, said the Reserve Bank.
Over the past 30 years, mortgages compared to incomes have increased sharply. At present, around 27% of mortgage lending has a DTI of six times household income, while a further 13% of borrowers have a mortgage of between five and six times the amount they earn. Amongst New Zealand’s big five banks, nearly 60 per cent of Auckland lending involves a DTI ratio of more than five.
What exactly is DTI?
A debt-to-income (DTI) ratio is one way in which lenders measure a borrower’s ability to manage their mortgage repayments. It’s calculated by dividing the borrower’s total recurring monthly debt by their gross monthly income, expressed as a percentage.
For example, if your total household expenses were $2,000 a month and your gross monthly income was $6,000, your DTI would be 33%. The lower your DTI, the better position you’re in to manage your mortgage repayments.
A speed limit approach
While the Reserve Bank said it would not consider using DTI restrictions in the current market, it wanted these measures in place to use alongside loan-to-value restrictions should market conditions change.
The Reserve Bank also said it would prefer a speed limit approach that would allow banks to lend a proportion of their loans to high-DTI borrowers. It would also consider exemptions for first-home buyers buying a relatively low-priced home or a newly built one.
The Property Institute of New Zealand has refuted the proposal, saying DTI restrictions would inflict significant damage on the Auckland housing market particularly, and on the wider economy.
Chief Executive of the Property Institute of New Zealand, Ashley Church said, “The number of new homes being built, the very thing that Auckland needs most, would plunge as the number of people earning enough to build or buy them would dwindle to a trickle.”
“The policy could very well kill off the one thing that can fix the Auckland housing crisis — the construction of new homes,” he said.
Mr Church says the introduction of DTI restrictions alongside current LVI restrictions would create a further barrier to first-home buyers entering the market. It would also severely restrict or even eliminate small business owners’ ability to use their home equity as security for cash-flow, potentially putting thousands of small businesses at risk.
Being used in other countries
In other countries around the world, DTI ratios are currently being used; the United Kingdom introduced a similar policy in 2014 which restricts home buyers to a mortgage not exceeding 4.5 times their annual earnings. However, the policy is not compulsory and only applies to a section of the market, used as a tool to protect those most at risk of a market crash.
Mr Church believes that introducing a DTI ratio could negatively impact the rental market, pushing up rents over a relatively short timeframe as property investors try to increase their income in order to meet the DTI ratio and buy more property.
How secure are your finances?
With proposed changes to the mortgage industry, it’s more important than ever to get sound financial advice from your mortgage adviser. Get in touch with one of our advisers if you’d like to talk about your financial future and how to set in place a plan to improve your debt-to-income ratio.
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