For the past decade, we have seen the housing market take off on a bullish run due to historically low interest rates, high demand for housing, and low supply, amongst other factors.
This has made people feel wealthier and willing to spend more, whilst others have been left out in the cold due to the increasing house price to income gap.
To try and combat this, the Reserve bank has recently adjusted LVRs (Loan-To-Value) to restrict consumers’ borrowing capacities. The government has also implemented policies like the Kiwi Build initiative and non tax deductibility of rental income to help control rising prices in the market and assist people trying to enter the market.
The latest widely discussed "future" Reserve Bank policy being considered for introduction to the NZ banking sector, is the Debt-To-Income (DTI) ratio, which has been both embraced and despised by finance industry workers and consumers alike.
What is DTI?
DTI ratio is a servicing measure based on a borrower’s annual gross income to identify how much debt is sensible for them to borrow.
The main purpose of the DTI is to mitigate the vulnerability of the banking sector to an unsustainable housing market, through limiting the borrowing ability of consumers based on a multiple of their income (6 to 7 times their gross income). In short, they are ensuring that consumers aren't taking on too much debt.
DTI is calculated as total household debt (mortgage, consumer, credit card etc.) / total gross income.
Some banks (ASB & BNZ) have already begun to introduce DTI into their assessment processes in anticipation of the Reserve Bank implementing this in 2022, but the Reserve Bank is yet to give the go ahead.
So, what does this mean for current and future borrowers? And what are some of the best ways to combat this change?
DTI Impact on Property Investors
Property investors will be hit the hardest and will find it more challenging to secure lending from the banks. This is due to the banks now not only taking into consideration the borrower’s capability to service the debt, but also, consideration of the borrower’s total DTI in relation to their gross income plus roughly 80% of any rental income.
This becomes an issue for those investors who already own a number of investment properties, as the debt of these investment properties will be factored into the borrower’s total DTI ratio along with their personal home(s), restricting further lending depending on their current debt and income levels.
For example, an investor who is looking to purchase a new investment property for $600,000 with a rental income of $460pw or $23,920pa, can firstly expect the bank to scale the rental income back by 80% or the equivalent of $19,136pa. They would then take this $19,136 and apply their DTI ratio (x6 or x7, x6 for this example), giving a total debt of $114,816 to use against the total property purchase ($600,000), leaving a remaining debt of $485,184 needing to be contributed towards the purchase. This remaining amount would need to be relied on by either the investors personal income or other income equivalent to $80,864pa.
DTI Impact on First Home Buyers
First home buyers looking to get into the market are already being hamstrung by a reduction of LVRs (banks will currently only lend on = or < 80%), along with rapidly rising house prices and an increase in interest rates, an introduction of the DTI ratios could be the nail in the coffin for first home buyers’ confidence of ever buying their first home.
The DTI policy will cap borrowing, limiting first home buyers’ max purchase price (similarly to investors). With a growing gap between income and housing prices, lower income households could feel the effects of DTI more significantly than others.
For example, the median house price in NZ is now $895,000, less a 20% deposit of (min deposit needed for FHB) $179,000, gives a total debt of $716,000. Taking the total debt divided by 6 (max DTI ratio on owner occupied) gives us total gross required household income of $120,000. NZ’s median gross household income according to the Stats.govt.nz June 2021 quarter report is equal to $113,672 per annum, meaning that the average household income falls short of the total required gross household income to purchase a median priced home by $6,328pa.
This is all before taking into consideration serviceability of the loan which, given the median gross household income level plus any consumer debt, would mean it is not possible for a median household to service the median NZ house price debt ($716,000).
How can you combat this change?
So, what are the best ways in which you, as a borrower can combat this change?
Well, there are a few ways in which this can be done, but the most effective and most self-explanatory way is increasing your household income. This is a lot easier said than done with not all employers willing to offer you a pay rise if requested, and it all depends on your employment situation, BUT there is NO harm in asking!
With the housing market being a tough market to get into you would be surprised at the type of support people are willing to offer.
Rental is another key way in which you can increase your DTI, and the good news for both investors and FHB alike is that the banks will consider the future income of a property or future boarder/renter income when assessing your DTI.
Combating DTI: Investors
For investors looking to purchase a property, the banks will consider the future rental income discounted/scaled at around 65% for an existing home, and 75% for a new build (this varies depending on the bank). For example, if the property was a new build and the rental income was estimated to be $600 per week, the banks would consider $450 of that as income per week. This income can then be treated as additional DTI by calculating the annual gross income ($450 x 52 = $23,400) multiplied by the DTI ratio (x6) to give an additional DTI of $140,400.
This rental income will vary property to property and the banks may require a rental appraisal or tenancy agreement to confirm the income.
The banks will also consider boarder/renter income if the investor has a current boarder/renter in their own home, more on that below.
Combating DTI: First Home Buyers
For buyers who are looking to purchase their first home, the banks will consider future boarder/renter income, but similarly to investment rental income, most banks have a cap on this, and will also discount/scale the income back.
Generally speaking, the main banks will look at around $150pw to $250pw for either 1 or 2 boarders, and will scale this depending on the income received (whether this inclusive of expenses or not). If you choose to work with us, we can clarify what this would look like for your specific bank, or advise which banks give the best support for this.
Let’s use the example that you as a borrower were purchasing your first home, and that you were going to have a boarder/renter in the premises at $150pw scaled to 80% or $120pw. This would give you an annual gross boarder/rental income of $6,240, and in turn an additional DTI (x6) of $37,440.
This may not seem to be a lot in the scheme of housing prices currently, but every dollar of additional debt you can add to your budget gives you stronger purchasing power.
In saying all of this, we are yet to see this to be officially announced by the Reserve Bank and fully implemented by all banks, but our expectation is that we will see it come into play mid 2022.
We cannot stress enough that with a continually changing residential market, it is always best to seek advice from an industry professional, and hey, It doesn't cost you anything to have a no strings attached conversation with the team here at Lateral Partners. You can get in touch with us here.
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