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Reserve Bank outlines design plans for tool it could enforce on banks to limit the debt-to-income ratio of home buyers

Banking / news
Reserve Bank outlines design plans for tool it could enforce on banks to limit the debt-to-income ratio of home buyers
dti

The Reserve Bank (RBNZ) says it could have a debt-to-income (DTI) limiting tool for lenders to use on borrowers taking out home loans ready to go in March 2024, should the policy survive the 2023 election.

In the latest consultation paper in the long running saga of the RBNZ's quest to add a DTI tool to its macro-prudential toolkit, the regulator covers off a range of "design questions" needing to be answered before a DTI limit can be implemented.

DTI limits are calculated based on a simple ratio of borrower debt divided by borrower income. The RBNZ emphasizes that it hasn't made a decision to activate DTI restrictions and isn't consulting on a particular DTI setting at this stage. It plans to consult separately on calibration in 2023, before any decision is made to actually use the restrictions.

"Debt serviceability restrictions are a macroprudential policy tool used to support financial stability and sustainable house prices by reducing the risk of ‘boom-bust’ credit cycles that amplify downturns in the real economy. They complement loan-to-value ratio (LVR) restrictions on mortgage lending, another macroprudential tool the Reserve Bank has been using in recent years," the RBNZ says.

The new consultation paper features views on how banks should measure income and debt when they calculate DTI ratios, how banks should deal with complex lending situations such as multiple borrowers, whether there should be exemptions to the DTI restrictions, and whether DTI restrictions should be the same or different depending on the type of property owner for example, investment or owner-occupied.

"Banks have told us they need around 12 months to prepare their systems for possible implementation of DTI restrictions. If we do decide to implement DTI restrictions, the earliest date we could do so is likely to be March 2024," the RBNZ says.

If DTI restrictions are ever actually enforced, the RBNZ says they'll feature a ‘speed limit’ combined with a threshold or cap, as is the case with LVR restrictions.

"For example, the DTI restriction could be set at a maximum of 20% of [a lender's] new mortgage lending, the speed limit, at a DTI over seven [being] the threshold or cap. We intend to set the speed limit based on the value of new loans, rather than the number of loans, which again is the same approach as for the LVR restrictions," the RBNZ says.

Long running saga

The RBNZ has wanted to have the option of using a DTI tool since at least 2016 but struggled to secure government support from firstly the National-led government and then the current Labour government due to concerns about the potential impact on first home buyers. It finally gained support from Finance Minister Grant Robertson in June last year.

Introduction of the tool has also been opposed by banks, with bank lobby group the New Zealand Bankers' Association maintaining "there's a real risk of adverse customer impact" if the RBNZ introduces a DTI tool.

In a consultation paper in November 2021, the RBNZ assessed the impacts of introducing a DTI cap for borrowers of six or seven times gross income and a test interest rate floor for bank lenders of 7% or 8%, but stressed these were merely illustrative models. It also talked down the potential impact of DTIs on first home buyers.

Then in April this year the RBNZ said it would push ahead with developing a DTI tool framework, but would leave banks to set the interest rates they use to to test new borrowers' ability to cope with rising interest rates. It argues DTI restrictions are likely to be more effective than test rate floors in supporting financial stability and sustainable house prices, adding DTI restrictions also have less impact on access to debt for first-home buyers because they borrow at lower DTI multiples on average than property investors and existing owner-occupiers.

Treatment of personal income 

The RBNZ plans to measure borrowers' income on a gross pre-tax basis. It says this approach has the advantage of simplicity, and is independent of any future tax changes.

"We propose to allow all forms of personal income to be included within the DTI calculation, including wages and salaries, rental income, boarder income, investment income, foreign income, bonus income, and income from Government benefits," the RBNZ says.

"Business income will also be included, to the extent that it is available to service residential mortgage debt and other personal debt."

In terms of variable income such as commissions and bonuses, the RBNZ is proposing to let banks apply their own internal lending policies but is seeking feedback on this.

Treatment of debt

The RBNZ is proposing to include all forms of personal debt such as mortgage debt, credit card debt, personal loans, and student loans within the DTI calculation except buy now pay later (BNPL) debt.

"In our discussions with banks, some have stated that they treat BNPL as an expense rather than debt. This is because it can be difficult to calculate borrowing limits under BNPL, and also BNPL is not currently included in the information held by credit agencies. Banks have also noted that in most cases BNPL accounts for only a very small proportion of total debt."

"For these reasons, our current view is that BNPL can be excluded from the DTI calculation and the draft framework reflects this. However, we welcome feedback on this point," the RBNZ says.

Business income & debt

Given the purpose of DTI restrictions is to reduce systemic risk associated with residential mortgage lending, the RBNZ says business debt should generally be excluded from the DTI calculation when held separately from mortgage debt.

It proposes to include in DTI calculations taxable business profits, regardless of whether the profits are taken as personal income or retained within the business. Taxable profits would exclude interest payments on business debt because these are normally treated as a business expense. For businesses with more than one shareholder, profits would reflect the borrower’s equity share in the business.

"Where business income is being used to service residential mortgage lending, this income should be included in the DTI calculation."

"Provisionally, we are minded to deduct principal payments on business debt from the calculation of business income, as these directly reduce the amount of income available to service residential mortgage debt. We are minded not to allow forecasts of future business income to be permitted, as it would introduce too much uncertainty into the calculation - but we note that the speed limit could be used to accommodate customers with high levels of forecast business income," the RBNZ says.

Complex lending scenarios

The consultation paper also looks at what are described as complex lending situations, where it could be difficult for lenders to calculate a DTI ratio. The RBNZ suggests these scenarios could account for between 5% and 10% of all residential mortgage lending.

"There are two main potential sources of complexity: firstly, complex structures such as trusts and look-through companies; and secondly, situations with multiple borrowers and multiple properties, particularly where the borrowing entities are interlinked but do not fully overlap," the RBNZ says.

It's proposing a combination of allocating complex lending to a general speed limit, and when calibrating the speed limit, ensure it's sufficiently large to cover complex lending situations, and developing rules or guidance for the calculation of DTI ratios in complex lending situations.

"Specifically, we have drafted a set of rules that we consider should cover a significant share, 50% or more, of complex situations. For the remainder of situations, which we refer to as ‘very complex’, lending would be allocated to the general speed limit. We welcome feedback on these rules," the RBNZ says.

Exemptions

An exemption regime is proposed for the DTI restrictions that's similar to the one for LVR restrictions. This would include exemptions for; loans made under Kainga Ora’s first home loan scheme, loan refinancing, loan portability, bridging finance, new housing construction, and loans granted in error.

"We consider that the rationale for these exemptions applies equally to DTI restrictions as it does to LVR restrictions," the RBNZ says.

DTIs won't be differentiated by borrower type

Meanwhile, the regulator says it has also considered whether to differentiate the DTI restrictions by property or borrower type.

"However, feedback received from some banks indicates that this could add significant complexity. Moreover, the analysis we presented in our 2021 DTI consultation document showed that investors borrow at much higher DTIs on average, and hence would still be the group most affected under a uniform DTI limit," the RBNZ says.

"Therefore, for simplicity we propose to apply a uniform DTI limit across all mortgage lending and this is reflected in the draft framework."

And, as with the LVR restrictions, the RBNZ plans to measure lender compliance over a rolling period being three months for larger banks, and six months for smaller banks. This will enable banks to manage "lumpiness" or variation in the flows of high-DTI lending, the RBNZ adds.

The RBNZ also says it plans modelling analysis to better understand the potential impacts of different DTI settings, including interactions with other policies such as the LVR restrictions.

"Submissions on this consultation close on 14 December 2022. Once we have considered the submissions, we will draft a final version of the DTI framework, which will need to be approved by the Reserve Bank Board. We expect to publish the final framework, along with a summary of submissions, in March or April 2023."

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41 Comments

Only a few years too late.

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17

Heavily politicized Paccy. And let's be real. It could just be another smoke signal from Kaumatua and Robbo not to drink too much from the open bar. Service charges can change and nobody on hand to deal with any mishaps. 

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1

Better late than never......no wait a minute.......yep too late.

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7

Efficiency of such tool resides on where the limit is set. In Europe mortgages are capped at around 33% of households incomes. Figures show on average 53% of households incomes go to the mortgage in NZ.

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10

Ownership rates are lower in the more prosperous countries mind. Because alongside potential value declines, less people can own homes when you reduce ability to borrow.

I suppose that might be a good thing.

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0

I don't see any significant difference in ownership there:

List of countries by home ownership rate - Wikipedia

It actually shows a higher rate in Europe on average.

 

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3

New Zealand's home ownership rate has behaved in the opposite fashion, over the last 50 years. When prices were lower and people could borrow less, the home ownership rate was higher.

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2

Horse, bolted! 

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4

Seriously Robbo and Orr will go down as the Laurie and Hardy in the annals of NZ financial History... About as useful as tits on a bull.

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14

If the Banks are against it, it must be a good thing for the public.

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8

Are they really though. They win no matter what. 

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1

but several of the banks are already doing this? BNZ and ASB 2 examples..

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0

Continuing to bolster credibility and confidence. 5 MOrr years! 

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2

This would be a great tool and used correctly could avoid the kind of carnage we saw with prices exploding after Covid. It puts a ceiling on credit availability when interest rates drop to silly levels, and puts an end to the property snowball method of building up a large property portfolio using equity from other properties.

I hope National don't get in and screw it up. Perfect opportunity for Luxon to show he can govern in the national interest and not in the self-interest of his portfolio. 

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13

The reason Mr Orr has set date of March 2024 after election as hoping that new government is formed and they withdraw the support to introduce DTI, which he will be happy to oblige otherwise why not April 2023.

Manipulation and Corruption.

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9

Que jokes about RBNZ independence. National the speculation party will want their banks debt tax rinsing model hindered by debt restrictions.

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1

Surely if National get in 7-Houses Luxon won't take the RBNZ's DTI tool away...surely...?

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1

How manay houses does Helon Clark's trusts own?

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0

Is Helen Clark running for election?

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2

I think they will need time for this housing crash to play out a bit, otherwise if prices are still high DTI restrictions won’t be feasible with current prices?

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3

Agree but IT changes take a long time as well...the DTI ratio will be the most politisised decision ever made in NZ, it decides who can and cannot buy and by definition will lock the npoor out of hjome ownership....   

Will we need a co governing committee of IWI and Pakeha, will we setup a seperate baord like health to decide on a Maori DTI number?

 

It all complex.

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2

Bang on time!

Genuinely LOL-worthy turn of events.

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2

It is like closing the stable gate after the houses have already bolted. 

They are quick to react in some things but painfully slow on others. 

 

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7

Seriously questionable why banks need 12 months to implement systems changes for DTI.  Just write a new credit policy amendment in the good old manual and get staff to follow it.  Not that hard folks.

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5

They will need to prove how they calculated dti for all loans going forward, its about compliance and reporting, but the go no go decision should not be hard.

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0

Interest rates will do the job for them so this is redundant. It simply won't be possible to have high dtis with higher interest rates and make record profits as well.

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1

Not redundant at all. Not immediately useful, sure, because interest rates are likely to be the limiting factor. But if we'd have had DTIs a few years ago we wouldn't have FHBs in negative equity right now, as DTIs would have stepped in to cap the massive house price rise and subsequent fall. 

There will be another time in the future that they are needed, and fingers crossed we actually get them in place this time. 

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7

The recent asset bubble was caused because of government intervention. You can't fix intervention with more intervention. 

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0

No, it was caused largely by the RBNZ reducing interest rates. More policy tools mean that can prevent these crazy side effects when they want to stimulate the economy.

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0

So you don't believe the RBNZ IS the govmt? How naive.

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0

I was calling for a DTI ten years ago!!! I’m just a dumb peasant non economist know nothing. If I could see it… what the hell were the authorities doing!?!

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7

March 2024 must be the bottom of the market?

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0

I agree

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0

at the current interest rates, DTI limits are irrelevant. You can't borrow more than you are able to pay back.

I'd say the bottom will be just before the next election votes are counted.

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0

Very similar in nature to the serviceability interest rate that banks already use.  Better for Reserve bank  to keep it simple and ask to set minimum serviceability limits as this will have little cost to the banks.

Adding new beaucratic rules won't help anyone.

Reducing interest rates too low caused the housing bubble,  with the serviceability rate now above 8% few people will get finance and the housing market will drift along at more realistic prices.

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1

We have people having to refix about what they were stress tested at. So no, the servicing tests aren't adequate and also not envision a world where all your other living costs explode as well.

We've tried letting the banks do it their way. They failed. Nice gig where you can fail at something like that and still post a $2b result.  

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3

If they failed they would be losing money and not posting a $2 billion profit. If the stress tests are inadequate the bank will lose money, there's no reason for the RBNZ to step in and pretend it knows how to run the banks credit books better than the banks themselves. The ones who have failed New Zealanders are the RBNZ with inflation at 7%.

Maybe the banks should be the ones telling the RBNZ how to run their monetary policy, they've clearly proven themselves more capable at delivering for their stakeholders than RBNZ have!

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1

Indeed, look at their amazing investment in technology and enablement of open banking as examples where, clearly , no regulation is required.....

but these needed initiatives would not benefit the shareholders in the short term, and we are always focused on the full year result now, not in ten years....

 

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0

Do we know how many years it will be before the RBNZ can hit their inflation target? Why should we have any confidence they know what they're doing with their macroprudential tools when they have proven themselves to be incompetent at the execution of their primary role?

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1

It feels like the RBNZ will limit bank lending via DTI, why is it that bankls are so happy to lend at hight DTI if it's so unstable and dangerous?

I thought all the stress tests show all is well and BNZ head says long haul owners will be ok with negitive equity?

Does it open the door for 2nd mortgages?

Prices have to fall perhaps 40-50% before they can even propose a sane DTI IMHO, and then they will be accused of killing the bounce that the BNZ head talks about, imagine 40% falls then DTI of 3.5-4    the negitive equity owners will still be negitive in 20 years in real terms.

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3

They simply won't apply this policy into a cratering property market. Will never see the light of day.

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0