Will DTI fail to materialise again? Government delays decisive action as soaring house prices prove hard to stop!

With June approaching, Reserve Bank Governor Adrian Orr said yesterday that the analysis of introducing DTI restrictions had been completed and the findings reported to Finance Minister Grant Robertson. However, the final outcome has still not been made public. Even if the minister authorises the Reserve Bank to introduce DTI restrictions, the policy would not take effect until November at the earliest.

After repeated delays, DTI remains a ‘sword of Damocles’ hanging over the market, with no one knowing when it will fall. 

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“Menacing’ DTI

The debt-to-income ratio, or DTI, is an important tool for assessing borrowers' ability to repay loans. As a means of limiting total borrowing, it uses borrowers' income to determine their maximum loan amount. DTI is generally calculated monthly: DTI = Monthly Debt/Monthly Income, the ratio of monthly debt to monthly income.

DTI policies have been in place in the UK and US for many years, with both countries requiring debt-to-income ratios not to exceed 4.5. New Zealand currently has no mandatory DTI rules, although individual banks have their own risk management standards. In recent years, however, soaring house prices and large numbers of investors topping up loans to buy second and third homes have pushed the DTI ratios of New Zealand bank lending to a very high threshold. 

In the Reserve Bank of New Zealand's initial consultation paper, the DTI ratio would be set at 5, limiting an individual's borrowing to less than 5 times their income. In other words, if a DTI policy is implemented, the Reserve Bank is likely to require commercial banks' DTI ratios not to exceed 5.

According to a survey report released in late February by international research organisation Demographia, the ratio of New Zealand's median house price to median household income has reached 7, rising to 10 in Auckland. This means that a couple earning the national median income would fall far short of being able to buy a home at the national median price if their mortgage were limited to 5 times their income.

The main difference from the familiar loan-to-value ratio (Loan to value ratio, LVR) is that DTI places a firm constraint on homebuyers' borrowing capacity. Household incomes are unlikely to rocket upwards like house prices, so the flexibility LVR allows as house prices rise could be entirely offset by DTI's rigid income limits. LVR essentially sets a minimum deposit, while DTI limits mortgage size to what a household can afford. During an upswing in house prices, DTI can control household debt more effectively than LVR.

For example, an ordinary Auckland household earns NZ$100,000 a year. Based on Auckland's current average house price of NZ$1,200,000, an LVR of 80% would allow it to borrow up to NZ$960,000, requiring a deposit of just $240,000. Under DTI, however, the household's maximum bank mortgage would be only NZ$500,000, meaning it would need to contribute NZ$700,000 of its own money as a deposit. 

Clearly, DTI is much stricter than current lending policies. For homebuyers with limited budgets in particular, it would be nothing short of a disaster.

 

DTI's past and present

Perhaps it is precisely because DTI's full ‘power’ is recognised that it has repeatedly been proposed, only to be shelved again.

DTI first came to New Zealanders' attention in June 2017, when the Reserve Bank released a consultation paper on adding DTI policy to its macroeconomic emergency intervention toolkit.

The consultation paper argued that DTI, alongside LVR, would act as a ‘speed limiter’ on house prices. Once implemented, the risk of New Zealand's housing market halving in value would fall from 5% to 4%, while the risk of a financial crisis would fall from 1.5% to 1%. Losses from a halving of the housing market would also fall from 10% to 8%, and losses from a financial crisis from 20% to 16%.

The consultation paper also noted that the Reserve Bank fully recognised the social risks of DTI restrictions: a substantial proportion of households would lose the ability to buy a home. Then Finance Minister Steven Joyce said DTI would have a ‘significant impact’ on the housing market, so the Reserve Bank would not introduce it ‘immediately’. However, he also believed the policy was ‘very likely to be used in future’.

In the consultation paper, the Reserve Bank stressed that ‘DTI is the most effective measure when house prices surge again’. Perhaps this explains why this ‘powerful weapon’ has periodically been brought out over the past 4 years: 

In April 2018, the International Monetary Fund (IMF) visited New Zealand and released a research report expressing concern about the country's excessively high household debt. Andrian Orr responded by publicly supporting the addition of DTI to the macroprudential toolkit.

In 2020, when the housing market reached fever pitch, DTI returned to the spotlight:

In October, Brad Olsen, a senior economist at economic analysis firm Infometrics, told the media that the Reserve Bank might also be considering DTI restrictions to ensure investors did not place excessive pressure on the market.

In November, Grant Robertson wrote to the Reserve Bank asking it to include house prices in its monetary policy remit. Responding to the Treasury's proposal, the Reserve Bank asked the Government to ‘consider adding the DTI tool to its prudential toolkit in 2021’.

Robertson said the Government was ‘obliged’ to consider the Reserve Bank's DTI request, ‘but that does not mean automatic approval’. He noted that when the Reserve Bank last sought the tool, the National-led government of the time raised affordability concerns, particularly for first-home buyers and people on low incomes. The Labour Government had consistently worked to help these groups enter the housing market.

When the housing policy package was announced in March 2021, a new date was set for a decision on DTI: May. Yet whether this ‘sword hanging overhead’ will actually fall remains unresolved.

 

Divided opinions on DTI

Just as the Government and ministers have wavered, economists remain divided over the advantages and disadvantages of this ‘major intervention’.

Kiwibank senior economist Jeremy Couchman believes that DTI helps financial stability. However, with mortgage rates expected to rise next year, borrowers with high debt-to-income ratios would then be significantly affected.

Sense Partners economist Shamubeel Eaqub also says that DTI could help reverse the decades-long flow of credit into mortgages, driven by the housing market's relatively low risk, and redirect it towards more economically productive sectors.

However, he also worries that this would be less fair to first-home buyers, shutting them out of the property market. Their income mainly comes from wages, whereas investors have other resources, such as using existing properties as security.

Plaxo Mortgages chairman York Zhang, however, believes that DTI would have no practical impact on first-home buyers. Even if the Government introduced DTI, it would distinguish between first-home buyers, genuine investors and so-called property ‘speculators’. The Government's primary purpose in controlling house prices is to help residents with genuine needs buy or rent affordable homes, rather than shut them out of the market.

York also noted that the housing policies introduced in March were already showing results: house prices were being brought under control and growth was slowing, so the Government would not introduce further policies in the short term. Even if DTI were introduced, commercial banks had already imposed very strict lending requirements during the pandemic and had their own criteria for assessing borrowers' incomes. Its impact on borrowers would therefore be limited, with no need for excessive concern.

 

About the expert

York Zhang (Zhang Yong) 

Chairman of Plaxo Mortgages 

In 2006, York Zhang (Zhang Yong) founded Plaxo Mortgages to provide the Chinese community with loans for housing, construction, business, land development, vehicles and heavy equipment. Combining his mortgage broking expertise with his personal experience of living in New Zealand, York Zhang hopes to use Plaxo Mortgages to bring more products tailored to the Chinese community's characteristics and needs to market, develop more outstanding mortgage brokers, and release more funds from Chinese clients' assets for reinvestment.