Debt-to-income rules could just make rich richer

The Reserve Bank has been mulling over debt-to-income (DTI) ratios for years, but it just got real: The framework to underpin their introduction is now in the works.

The central bank has not yet told us when these restrictions could come into force, except to say they are at least a year away.

But mark my words: This will have a chilling effect on mortgage lending regardless, with the Reserve Bank expecting banks to start pulling back on high debt-to-income lending ahead of the formal framework being introduced.

(Of course, things are already fairly chilly in the wake of the CCCFA legislation changes introduced last year, rising interest rates and the reintroduction of loanto-value ratio restrictions.)

We’re not alone in looking at such restrictions. The United Kingdom has a debt-to-income limit of about 4.5 times income, and various banks in Australia have voluntary limits of between seven and nine.

The United States looks at it differently, focusing on the percentage of your total income spent servicing debt.

Two banks here – BNZ and ASB – last year implemented debt-toincome ratio restrictions on lending at more than six to seven times income, depending on whether the borrower is an existing client or not. Only ASB is still applying them.

I’d suggest that our house prices are too high and our incomes too low to countenance a UK-like limit. Especially because governments of both flavours have made it clear they don’t wish to lock more first-home buyers out of the housing market.

Although no set multiple has been confirmed, the Reserve Bank has given us enough hints to allow for an educated guess. Six seems too low to avoid hitting first-home buyers – to me, seven seems more likely.

The Reserve Bank says the DTI rules would hit investors the hardest, rather than first-home buyers. I would go further and say that it will be middle-class ‘‘mum and dad’’ investors who are trying hard to grow their wealth with leverage who will bear the brunt.

Helpfully for the Government, such investors elicit little sympathy from the voting public, but that attitude overlooks the fact that the strength of any economy is the middle class. If you make it harder for them to get ahead, you weaken the economy overall.

The vast majority of property investors are small-time – they own one investment property and they’re not in the game to build their fortunes, but rather to build enough wealth to afford to retire. Hitting them hard has big consequences for Kiwis’ retirement problem – and for the next generation they want to help onto the housing ladder.

While there’s still much we don’t know about exactly how the Reserve Bank’s DTI framework will operate, there are hints in its response to submissions on the issue.

The central bank acknowledges that, like loan-to-value ratio (LVR) restrictions, there’s a risk that DTIs will result in investment in new housing being deferred – that is, reducing supply of new homes. That’s a problem. That correlation to LVR rules is important because the LVR framework includes a speed limit – so that a small proportion of loans that don’t meet the criteria are still possible – and new-build properties are exempt.

I think it’s important there are exemptions for new builds. It seems ludicrous to undermine the supply of new housing when we already have a housing supply problem, especially as that would seem to undermine the stated goal of improving housing affordability.

Without exemptions and nuance in the legislation, I’d expect to see supply of new houses decline.

In my mind, DTIs are a fairly blunt assessment of affordability. You and I might earn the same, but we’ll spend very differently. I might have savings, you might not – so debt as a multiple of our income doesn’t mean we can both afford to service the same level of debt.

The bank here that uses DTIs has a fairly nuanced approach. If a borrower’s debt-to-income ratio breaches the limit, the bank will usually want to see a higher uncommitted monthly income – that is, their surplus – which is really what determines whether a borrower can afford a loan or not.

There’s still a lot of water to go under the bridge, but without exemptions and nuance in the legislation, I’d expect to see supply of new houses decline, and lending by second-tier lenders increase – which could push up rents and result in the middle class becoming further stretched.

There will be some who will choose to syndicate to get around the issue, but I think property will become more tightly held by the already wealthy – that is, those who don’t need lending to invest.

Ultimately, we could end up with more Kiwis underprepared for retirement – which will become everyone’s problem.

Hannah McQueen is a chartered accountant fellow, a financial adviser, a personal finance author, holds a master of taxation studies degree, and founded enable.me – financial strategy and coaching. This column is informational only and should not be considered individual financial advice.