In response to feedback received on its proposed policy for debt serviceability restrictions (DSRs) on residential mortgage lending, the Reserve Bank of New Zealand said it will design a framework for debt-to-income (DTI) restrictions.
What are debt to income ratios?
A debt-to-income ratio (DTI) measures the percentage of your gross monthly income that goes to paying your monthly debt payments and was first introduced to help lenders determine your borrowing risk. It’s a simple calculation that uses your income and debt repayments, but where it can get complex is when income is more difficult to calculate such as people that have irregular income or self employed.
The Reserve Bank sought feedback in November 2021 on the merits and the potential design on a Debt to Income system which if introduced would impose a cap on how much debt someone can have as a multiple of what income they have.
Of course the participants in the financial services industry (banks, lenders and advisers) are not keen on a set of rules being imposed, as so often we have seen these types of rules not work as intended.
There are so many variables and when rules are set in concrete there will be situations that no longer work.
Consider what defines income – in many cases a persons income is defined as the taxable income as defined by IRD, for many other cases it may be the base income or there are times when allowances and extra income can be used or at least part of that income (scaled) may be able to be used in a calculation to determine income. At the moment those banks that use a DTI already (ASB and BNZ) use their bank policy to determine what is income and therefore use that when calculating what the maximum borrowing can be.
This may hurt first home buyers the most – many first home buyers are younger and therefore may be on lower incomes; however with the potential to earn more. For this reason they may decide to commit to a mortgage that may seem at the upper end of what they can afford, but today the bank is still able to approve this for them. Of course this makes sense and can be a prudent decision especially if the housing prices are increasing as they so often do.
Sophie (name changed) is a 26-year old lawyer that is 2-years out of university. She has recently started with a new law firm and is on a starting salary of $80,000pa plus bonuses but her income is expected to increase quite quickly. The median salary for a lawyer in New Zealand is $115,848pa. Should she be restricted in what she can buy now?
Do we want all bank policy to be the same?
One fear that mortgage advisers have is that as the Reserve Bank introduce more rules then the banks policies all become very similar and effectively it wipes lout the options and choice that currently exists.
To many people the banks mortgages all look the same and the only difference is the interest rates offered. That is the unfortunate result of lazy marketing by the banks; however a good mortgage adviser can show you that there are some significant differences with mortgages that make some a lot more desirable for a given situation.
When Could We See Debt To Income Ratios Introduced?
We hear that the Reserve Bank intends to have the framework finalised by late 2022, so that restrictions could be introduced by mid-2023 if required.
This may seem like quite a while away, but it will be upon us before we know it.
One of the key issues with the introduction of debt to income ratios is it may limit what you can borrow, and even for people with a mortgage already it may limit or totally void the ability to refinance.
Just imagine how annoyed you would be if you wanted to refinance to a better mortgage and the bank said they could not approve you as the rules that determine the debt to income ratios now exclude you.
This can happen and we’ve seen plenty of people have rules introduced by the Reserve Bank stop them from making what would be sensible and financially prudent decisions.
Do We Want Debt To Income Ratios Introduced?
I think most people would prefer less rules not more.
Of course society does need some rules to protect people; however there must be a point when we need to say enough is enough. We already have a huge amount of rules that govern what banks and lenders can and cannot do and in most cases things have been working okay in New Zealand.
The banks and other lenders already have their own ways to check that someone can afford the repayments and they are also governed by the Responsible Lending Code.