Mortgage lending restrictions reach critical stage

DTI and LVR changes generally positive, advisers say

Mortgage lending restrictions reach critical stage

Income will soon be a factor in determining the maximum amount of money banks can lend to residential borrowers to finance property.

The Reserve Bank of New Zealand (RBNZ) intends to implement debt-to-income (DTI) restrictions for owner-occupiers and investors. The restrictions place a limit on the amount of lending households can take on, as a multiple of their income.

On Tuesday, it released proposed settings on DTI restrictions for consultation, which it expects to announce mid-year, along with an easing of loan-to-value (LVR) ratios.

Mortgage advisers NZ Adviser spoke to said that while they were comfortable with the proposed DTIs, it would be important to clarify the definition of income and who would set it and to ensure the needs of small businesses leveraging residential lending for capital needs are considered.

The regulator is proposing that no more than 20% of residential loans issued to owner-occupiers will be to applicants looking to borrow more than six times their gross annual income.

For investors, it is proposing that no more than 20% of loans issued to this group will be to applicants wanting to borrow more than seven times their income.

Squirrel founder John Bolton (pictured above left) said that while he had initially viewed DTIs as a “blunt tool” he had become more comfortable with the implementation of DTI restrictions.

Bolton said that a DTI of six for owner-occupiers was high, noting that not too many mortgages are over this threshold.  A DTI of seven is reasonable for most property investors, he said.

"The reality is that borrowers are already faced with servicing rates of 8.50% to 9% from the banks, and banks test property investors on principal and interest repayments.  It's not all that different to the impact from a DTI," he said.

Eugene Bartsaikin (pictured above right), director and mortgage adviser at Twine Financial Advisers, said that in principle, the proposed DTIs are "not a problem", noting that he agreed with the view that DTIs would act as a guardrail to prevent excess levels of risky lending.

"If the DTI restrictions were in place today, they shouldn't have any real negative impact to peoples' borrowing power," he said.

As of today, bank stress tests generally limit people to a five times DTI, (a little bit more or less some circumstances), indicating that DTI restrictions would not be a stumbling block for first home buyers, Bartsaikin said.

But the biggest concern is going to come down to the definition of income, he said.

Definition of income important for DTIs 

Bartsaikin said that it would be important to clarify whether banks would be able to assess the level of income and based on their assessment, the total income used for a certain borrower, or whether the Reserve Bank would mandate how income was defined.

That way, various borrowing scenarios, such as self-employed, bonuses, and stock options can be captured, he said.

“For example, if an investor has rental income and then salaried income, their rental income should count,” Bartsaikin said.

The question would be how much is taken into account, and whether income is based on tax returns, or how it is assessed, he said.

Needs of small business considered important

Bolton, who has provided feedback to the RBNZ on the proposed changes, said that he considered small business lending to be one of the outliers that would need further consideration, along with large-scale property investors.

"Businesses need access to capital and many leverage residential lending to do so.  If profits are down, suddenly they may not meet DTI restrictions," Bolton said.

"This is a scenario that needs to be thought through during the consultation process."

DTIs and interest rates

Bolton said that banks tend to lend too much when interest rates were low. Now that interest rates are higher, they are too restrictive, he said.

"We have servicing rates of over 8.50% at a time that borrowers are paying 7% at the top of a cycle.  Equally when rates were at less than 3%, banks were testing at 5.5%, which was too low," Bolton said.

As a DTI of six or seven would remain constant through an economic cycle, Bolton said that it would reduce the influence of interest rates on borrowing power.

"The last cycle has shown house prices have been heavily influenced by interest rates. This will reduce the impact and provide more stability," he said.

Noting that the Reserve Bank intends to implement the restrictions around mid-year, Bartsaikin said that while the proposed DTI restrictions, if in place today, are unlikely to have any real negative impact on peoples' borrowing power, as they act to limit excess levels of funding, they could have an impact as economic conditions change.

"If we were to wind the clock back to when interest rates were in the 2% range, then at that point in time it wasn't uncommon to see DTIs greater than six or than seven," he said.

However, the RBNZ’s proposal does not necessarily restrict a DTI at a certain level, but rather it provides a “speed limit” as to how many owner-occupiers or investors can exceed those DTIs, he said.

“This is a little better than what some other countries have, where they have firm limit and that’s all,” Bartsaikin said.

It will be interesting to see how banks implement the DTI, he said, noting that the proposed restrictions did not put banks in an unreasonable position.

"They still give [banks] a little bit of case-by-case basis perspective on whether they can go a little bit further."

Easing of LVR restrictions positive for first home buyers, investors

The RBNZ is also proposing to increase the cap on owner-occupier lending to borrowers with an LVR greater than 80% (deposits of less than 20%) from the current level of 15%, to 20%.

Bartsaikin said that the easing of LVR restrictions would give banks “a little more space” to take on low deposit borrowers, meaning the change would be positive for first home buyers.

Rather than take on all the business that they can, banks often prioritise their own customers first, he said. 

“Increasing the cap to 20% will give a lot more certainty that low deposit borrowers should have access to money, especially at their own existing banks,” Bartsaikin said.

For investors, the Reserve Bank is proposing that no more than 5% of lending can be to borrowers with an LVR greater than 70% (currently 65%).

While not a game-changer, Bartsaikin said that the proposed LVR increase for investors is "welcome news".

"Property values have significantly declined over the last two years, and so some investors are genuinely limited in terms of equity - especially if they want to invest in existing property stock," he said.

RBNZ deputy governor Christian Hawkesby said on Tuesday that the DTI restrictions were aimed at reducing the probability of a “systemic wave of households defaulting. The restrictions would reduce financial stability risks and support house price sustainability, filling a gap not covered by existing policies, he said.

“Introducing DTI restrictions will also allow us to loosen LVR settings without increasing risks to financial stability. Working together, these tools enable us to more efficiently target financial stability risks,” Hawkesby said.

The Reserve Bank has opened consultation on the proposed DTI settings and the easing of LVRs, which closes on March 12. The proposed changes apply to the bank lending, specifically mortgages. Information on how to give feedback is provided by the Reserve Bank here. It expects to announce its decisions in the middle of this year.