A new set of lending restrictions will come into effect in New Zealand starting on July 1, 2024.
Debt-to-income ratios—or DTIs, as they’re commonly known—will limit how much you can borrow to buy residential property based on a multiple of your income. That multiplier is six times for owner-occupiers and seven times for property investors.
DTI ratios are effective tools, which have been implemented well in many countries, but the design of the Reserve Bank’s DTI framework raises two big red flags.
Flags which suggest it has gone beyond what’s strictly required to achieve its stated goal (affordability and financial stability) and is instead starting to flex its muscles in ways it shouldn’t be: by meddling in housing policy.
Red Flag 1: The decision to apply DTIs to property investors, despite what the research (and best practice) tells us
One of the main reasons for implementing DTIs is to help prevent borrowers from taking on massive loans when interest rates are low, only to be stung badly—and end up in financial distress—as soon as interest rates start to climb.
You only need to read the news to see how devastating our latest interest rate hikes have been for Kiwi homeowners. So, for this part of the market, having DTIs in place makes a lot of sense.
But the RBNZ’s own research clearly shows that property investors are more resilient in a rising rate environment than owner-occupiers. At the current DTI settings, the data suggests that owner-occupiers would start to experience financial distress at a DTI of 6 times income and a mortgage rate of 7.00%. Property investors, meanwhile—even at a higher DTI limit of 8—wouldn’t experience distress until rates hit 8.00%. And that’s consistent with our real-world experience, too.
This is precisely why conventional wisdom (i.e. the approach other countries have taken with this sort of thing) is to enforce DTIs solely for owner-occupied borrowing, because that’s where the obvious affordability risk is.
So, why has the RBNZ ignored the evidence and set an overly conservative policy for investors? A policy setting that is pretty much guaranteed to restrict investor buying activity across all parts of the housing market cycle.
Red Flag 2: If DTIs are all about preventing borrowers from taking out loans they can’t afford, it’s tough to see how excluding new builds and Kāinga Ora loans makes any sense.
An unaffordable loan is an unaffordable loan, whether it’s on a new build or a second-hand home. So, why should one property type be subject to the rules and the other not?
In my view, the decision to exclude Kāinga Ora loans from the DTI restrictions makes even less sense.
Bearing in mind that these loans exist specifically to support low-income households into homeownership – households that are already most likely to be stretched in terms of affordability – these are the people the DTIs should be working hardest to protect.
So, what’s going on here?
The design of the new DTI framework feels like the RBNZ has wandered outside its swim lane.
Rather than sticking to the stated goal, the new rules will almost certainly influence the housing market in ways that go well beyond affordability or financial stability.
Let’s look again at the example of property investors. By making them subject to arguably the strictest DTI rules in the world (despite limited empirical evidence to support the move) and then putting an exemption in place for new builds, the clear message is that this is not about affordability—it’s more about the Reserve Bank wanting to push investors into new builds.
We’ve seen this behaviour from the RBNZ before, when it put in its LVR framework and made new builds and Kāinga Ora loans exempt. There wasn’t any logic behind that call, either, at least not from a financial stability perspective.
I’m not saying there’s anything wrong with encouraging more new-build activity in New Zealand—quite the opposite. But be honest, transparent and accountable.
And there will be unintended consequences to the RBNZ meddling in housing policy
The first is that property investors currently play a significant role in the second-hand housing market.
They buy and renovate old, tired properties, bringing them up to Healthy Homes standards, and then either rent them out or sell them. By pushing property investors out of the existing housing market and towards new builds instead, we’re missing out on the benefit of that investment.
The new build exemption also creates some complications.
New builds are exempt when the mortgage is first taken out, and so are refinances (if the loan amount is the same)—but what happens if, a few years down the line, you need to get a loan top-up for whatever reason?
That move will likely take you outside the DTI limits, in which case, unless the banks have room to accommodate high-DTI lending, you won’t be able to make it happen, and you will also be at the whim of the bank.
So, rather than pretending the DTI framework is all about affordability, why not call a spade a spade?
Again, I’m not against encouraging more new-build activity in New Zealand. It’s a crucial part of the solution we need to address housing shortages, reduce house price inflation, and create more affordable housing.
I’m also okay with using DTIs. They’re an effective tool for ensuring mortgage affordability for borrowers and will be a useful addition to the measures already in place to help keep our financial system stable.
But the new DTI framework isn’t all about affordability, as the RBNZ would have you believe.
I'm not convinced that our central bank should be involved in housing policy the way it is. At the very least, the RBNZ needs to be transparent about what it’s doing and why—not hiding behind weak arguments on financial stability.