How DTIs will affect mortgage advisers

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If the Reserve Bank implements its debt-to-income (DTI) restrictions tool, it will put enormous pressure on mortgage advisers, says David Green of Advice HQ.

Monday, May 8th 2023, 6:00AM 5 Comments

by Sally Lindsay

Although there is no indication from the Reserve Bank on if and when the tool will be introduced, many economists are picking it to be early next year in light of the loosening of the loan-to-value ratio (LVR) restrictions.

Green says it will place more value on mortgage advisers’ advice and the equations they give to clients so they can make decisions before approaching a bank for a mortgage.

He says there will be more work upfront for advisers on what options are open to clients, instead of letting them suffer the consequences of bad decisions later.

CoreLogic chief property economist Kelvin Davidson says DTIs seem almost certain from about March 2024 and have become an even greater likelihood since the RBNZ’s surprise move to loosen LVR ratio restrictions earlier than anticipated.  

Davidson says there are some key unknowns, such as whether the DTI limits will be a cap of six, seven or eight times that of income; whether there will be exemptions for new builds; and whether a speed limit system is likely as per LVR rules.

He says it is known banks will look at “all” income and debt when calculating DTIs, incorporating existing loans as well as the potential new mortgage being assessed and the rules will not apply to non-bank lenders.

Green says it is frustrating that little detail is known about how the DTI tool will eventually look and how banks will interpret it. “Every bank had their own take on the changes to the Credit Contracts and Consumer Finance (CCCFA) changes and it became muddied for advisers and borrowers. Nobody wants that to happen with any DTI tool.”

He says property investors with portfolios and new property investors will probably be the hardest hit by DTI restrictions.

Green is picking there will be unintended consequences for property investors with rental portfolios.

“If an investor is holding a portfolio, [and] the mortgage lending is on interest only and ends up sitting beyond the level the Reserve Bank sets the DTI at, they won’t be able to extend their borrowing, refinance or even change banks.”

Reserve Bank figures at April last year show a whopping 42% of investors who took out a new mortgage were on an interest-only loan.

Green says interest-only loans have been good for investors’ cash flow, particularly for those with highly leveraged properties.

He says if cross collateralised properties are involved when the DTI limit is set, it will be even more difficult.

“The DTI tool might stop investors from doing anything, or at the least will severely limit options on what they can do even though their bank might be happy with the level of lending they have and the DTI it is at.”

Modelling

Davidson says RBNZ modelling suggests that somebody who already has a large portfolio in the range of seven to 10 properties, and therefore higher existing debt levels, may not be able to secure their next property for a decade after the DTI system has been imposed.

Mum and dad investors with one rental property mortgaged beyond whatever the DTI level is set at and who want to buy another property or shift banks, may have to sell their home and might not be able to get back into the property market, says Green.

Davidson says somebody with a small portfolio of one to two properties may not be able to add their next one for at least five years. The bottom line is that income needs time to grow to service higher debt levels.

He says the natural response to the impending system changes could be for investors to bring forward their buying decisions and get into the market ahead of the DTIs.

This in turn could contribute to a floor under current house price falls (for better or worse), alongside other factors such as flattening mortgage rates, rising net migration, and probable LVR loosening.

Green says the upshot is more investors may turn to non-bank lending.

“Now is the time for investors to speak with their mortgage adviser about the possibility of having to work under the DTI restrictions and work out a strategy.

“Banks possibly already know what the DTI limit will be and are preparing for it.”

Lending falling

Davidson says it’s important to note that high DTI lending has fallen sharply over the past 12-18 months, as house prices have fallen, incomes have risen, risk tolerance has reduced, and mortgage rates have increased, which has limited debt servicing levels.

For example, in 2021, 35-40% of investor lending was done at a DTI of less than 7. That same figure had dropped to about 11% by the end of last year.

“This is all to say the early adjustment in LVRs could reflect the substantial decline in the proportion of high DTI lending and all but confirms a change in DTIs is on the cards,” he says.

At a DTI of seven, for somebody who had an income of $100,000 and existing debt levels of say $350,000, in basic terms the rules would allow for an extra $350,000 of new debt – bringing total debt to $700,000.

“For an investor looking at another purchase, the rental stream on that extra property will contribute to income and allow for some additional debt, how much will be decided by each specific lender,” he says.

“However, that simple example illustrates the restraints DTIs could have on investors’ ability to expand their portfolio in the short to medium-term. An extra $350,000 of debt may not go far in today’s market.”

And he says, DTIs also point to a lower assumption about the future long-term growth rate of house prices and therefore capital gains as price growth is more closely tied to income growth, which tends to average 3-4% per year.

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