The rapidly approaching debt-to-income squeeze

Wednesday, 6 November 2024

Mortgage rates are falling, and that will encourage more property buyers on to the market.

Property buyers will feel the impact of the Reserve Bank’s debt-to-income ratio (DTI) rules on mortgage lending much sooner than previously expected, experts say.

The rules, which limit how much people can borrow to a certain multiple of their annual income, were activated in July this year.

Only 20% of banks' new lending can now go to owner-occupiers with a DTI ratio of over six, while only 20% of new investor lending can have a DTI ratio of over seven.

But high interest rates have been keeping borrowing subdued, and the DTIs have been sitting in the background, rather than operating.

CoreLogic chief property economist Kelvin Davidson said that is set to change as interest rates are coming back faster than expected.

The Reserve Bank has cut the Official Cash Rate by 50 basis points, dropping it to 4.75%. The move has triggered immediate interest rate reductions across major banks, giving homeowners a break ahead of the holiday season. Zane Small reports.

One year fixed rates started the year above 7% across the board, but now that rate was sitting at 5.99% at many banks, and rates were expected to fall further over the next year, he said.

“The reaction to lower interest rates can be quite quick, and we estimate that a ‘typical’ mortgage rate of around 5.5% would entice more buyers back to the market.

“While the amount of lending above the levels specified in the DTIs is still below the banks’ 20% speed limit, it’s likely to rise as rates fall, and that means DTIs will become an issue sooner rather than later.”

He was not sure when buyers would actually start to get locked out of loans by the DTI rules as that depended on how quickly banks hit the speed limit in a more active market.

But buyers would need to start considering them, and it was plausible that it could be in the first half of next year, he said.

“The rules, which assess all debt from mortgages to student loans and car loans, and all income, including rental income, will impact on all buyer groups.

“It is investors who are likely to feel the biggest impact, even though their ratio is seven and they can factor in rental income. That’s because, historically, investors tend to borrow at higher DTIs and carry more debt.”

In contrast, the “typical” first home buyer was a couple without kids, probably on a reasonable income, and with much less debt, so most should still be able to buy, Davidson said.

CoreLogic’s Kelvin Davidson says investors are likely to be most affected by debt-to-income ratios.

“The reality is the rules will impact more in different areas too. Buying in Auckland and buying in a cheaper provincial market are very different propositions.”

He added that new builds were exempt from the rules, and that could be a workaround for investors.

Mortgage adviser Hamish Patel, from Mortgages Online, said buyers could start to feel the impact of DTIs within eight to 12 months.

But many owner-occupiers, including first home buyers, would already be pretty close to hitting a ratio of 6, he said.

“If there are reductions of about 0.5% to 1% on bank test rates, DTIs will be pretty close for many homeowners. As the level is seven for investors, they still have a bit more wiggle room, but they do tend to carry more debt.”

The impact of the rules would not necessarily be straightforward, and some investors would not be hit as hard as some homeowners, he said.

“If you have a big, beautiful $3 million mansion you are likely to be carrying more debt than someone with a more modest, long-held home and a lower end rental, for example.

New build properties are exempt from the debt-to-income ratios, and that will make them more attractive to some.

“As the rules will have less impact in less expensive areas, out-of-town investments may become more popular. Someone may not be able to buy an $800,000 property, but they can buy a $600,000 one in a different area.”

The ability to build new would become more important, so there was likely to be an increase in interest in properties that are sub-divisible, Patel said.

“Because new builds are exempt from the rules, there is scope there for people. That will help to promote building activity and boost housing stock, so that’s a good thing.”

In its latest housing market update, the Reserve Bank said the DTIs would play an important role in moderating demand cycles and reducing the build-up of risks.

But property commentator Ashley Church said the rules would be a disaster because of the impact they would have on first home buyers.

A first home buyer with a household income of $102,500, which was around the country’s median, would be limited to borrowing a maximum of $615,000, he said.

“Assuming they also had a 20% deposit of $142,500 the rules mean that their house buying budget would be restricted to about $757,500. Good luck buying something in Auckland or another big centre with that.”

It would prevent many first home buyers from getting into the market, just as past “ill-advised” loan-to-value hikes that limited the ability to get loans with deposits as little as 5% did, he said.

“They won’t have the same impact on existing homeowners looking to upgrade or buy a rental because they already have equity they can use to buy so won’t need to borrow as much.

“For investors, their returns might be impacted by the DTIs, and that will make it harder for many. But it won’t have the same buying impact as it will on first home buyers.”

The DTIs would not slow house price increases significantly, but they might temper the appetite of investors to get into the market, Church said.

“They have no value, and my pick is they will have such a terrible impact on first home buyers over the next few years that the Government will make the Reserve Bank reverse the policy.”