DEBT-TO-INCOME RESTRICTIONS ON LENDING: How & When This May Affect You.

Back in 2021, the Reserve Bank of New Zealand (RBNZ) was granted authority to implement Debt-To-Income ratios, known as DTI’s for banks and other lenders.?

Now that time has come as the RBNZ has confirmed this week that it will introduce DTIs from the 1st of July 2024.

Both owner-occupiers and investors will face the new restrictions but it'll be tighter for those wishing to borrow for investment properties.

So, from the 1st of July, banks will only be able to lend about 20% of their new lending to owner-occupier borrowers with a DTI ratio of more than six. That means, if your household earns a combined income of $100,000, your loan will be limited to $600,000.

For investors, banks will only be able to lend 20% of their new lending to this group with a DTI of more than seven.

The rules won't apply to Kainga Ora loans, new builds or refinances.

In this article, we will delve into the concept of DTIs, explore their potential impact on you as an owner occupier and/or investor and provide some helpful tips to improve your chances of securing a home loan.

What exactly are DTIs and How Are They Calculated?

Debt-To-Income ratios (DTIs) tie the amount you can borrow to your income.?

DTIs are calculations used by lenders to determine the maximum amount an individual or household can borrow based on their income.?

It’s a tool designed to assess the borrower's ability to manage their debt obligations and reduce the risk associated with excessive borrowing i.e defaulting on your mortgage payments.

DTIs are calculated by dividing your total debts by your gross annual income (before tax) to give you a ratio number.?

The higher the number, the higher your debt is relative to your income and therefore considered a higher risk to a lender.?

For example, if you owned your own home and had $5,000 worth of short term debt plus a $550,000 mortgage and your income was $90,000, your DTI ratio would be 6.17 - meaning your debt is 6.17 times your income.??

Now that the DTI limit is set at 6, you would be just outside the limit, so if you wanted to borrow more money in the future you would need to look at reducing your debt/mortgage or increasing your income to bring this back into line (assuming you weren’t one of the 20% mentioned above).

Potential Impact on Homebuyers & Investors

At the moment interest rates are high, which means “stress test rates” are high, so it's hard to borrow a lot of money right now.?

But when interest rates fall, the impact of DTI's will start to be felt as you won't be able to borrow as much as you otherwise could.

For example:

If you and your partner earn combined income of $100,000 a year, the maximum you will be eligible to borrow is:

$600,000 if you are an owner-occupier

$700,000 as an investor

Investors typically have higher DTIs than owner occupiers so it’s expected this group will be more impacted by the effects of DTI restrictions.?

For an investor looking at another purchase, it may restrict them from expanding their portfolio in the short to medium term as reported in this article ? by CoreLogic.?

“The RBNZ’s modelling suggests that somebody who already has a large portfolio in the range of seven to 10 properties and therefore higher existing debt levels, may not be able to secure their next property for a decade after a DTI system has been imposed. Similarly, somebody with a small portfolio of one to two properties may not be able to add their next one for at least five years. The bottom line is income needs time to grow to service higher debt levels”.

Exemptions to DTI Restrictions

There’s always an exception to the rule, so while DTI restrictions will apply to most borrowers purchasing an existing property, there are exemptions:

• Kāinga Ora loans.
• Refinancing a mortgage, where the new loan value doesn't exceed the original loan value.
• Portability – this is where you 'keep' your home loan when selling, by changing the property securing the mortgage from the old property to the new one.
• Bridging finance.
• Property Remediation (e.g leaky home).
• Construction loans - when you are constructing a new home or purchasing a newly built home from the developer within 6 months of completion or are purchasing as part of the KiwiBuild programme.

These exemptions aim to support the growth of new housing supply and encourage investment in the construction sector.

What Can You Do to Improve Your DTI Ratio?

When these new rules come into effect on the 1st of July 2024, it might pay to get yourself into a good position if you are thinking about buying a home, upgrading to a new one or expanding your property portfolio.??

Here are some things to start thinking about now, in order to help improve your debt-to-income ratio:

?? Reduce Your Expenses?

Reducing your monthly expenses can free up more money to pay off debt and improve your DTI ratio. Try to cut back on unnecessary expenses, shop around for cheaper internet and electricity or get a flatmate to help with the rent or current mortgage payments.

?? Increase Your Income?

Increasing your income can lower your DTI ratio. Remember, DTIs tie the amount you can borrow to your income. You could look at negotiating a pay rise, find a higher-paying job, or start a side hustle to generate additional income.

?? Consolidate Debt or Pay It Down If You Can

Consolidating multiple debts into one loan at a reduced rate can lower your monthly payments, freeing up more cash to pay down your total debt which will improve your DTI ratio. However, the ultimate DTI improver is to pay off that high-interest debt first like credit cards, car loans or personal loans. Get in touch if you would like us to arrange a debt consolidation loan for you!

The Importance of Working with a Mortgage Adviser

Navigating the complexities of potential DTI restrictions and their implications requires expert guidance.?

This is where working with a Mortgage Adviser can help in assisting you to understand the rules, assessing your borrowing capacity, and identifying lenders who may be more flexible or offer better terms.? Feel free to reach out to the team if you need a hand!