If you’ve read our last article on the OCR and interest rates, you’ll know when the Reserve Bank reduces the OCR, the wholesale rates banks borrow money from the Central Bank falls. This can result in our registered banks reducing their short-term interest and deposit rates.
POSSIBLE EFFECTS
Debt to Income (DTI) rules became operational on 1 July 2024. They are another of the macroprudential tools the Reserve Bank of New Zealand now has in its tool kit.
Under the rules, the amount of lending a bank can give to borrowers with high debt levels relative to the borrower’s income, is restricted. Essentially, the restrictions place a control over banks in that they are prohibited from taking on too much risky lending during economic boom times, which could result in high loan defaults during recessionary periods. The rules apply to all new lending for residential homes for both owners and investors.
It's expected the DTI rules will be somewhat restrictive, containing the pool of potential customers a bank can lend to. This may affect bank profits. The tradeoff is the existence of the rules could help stabilize our financial system by mitigating the risk of excessive lending and housing bubbles.
Currently under DTI restrictions, banks are permitted to lend 20% of their book to owner-occupier borrowers with a DTI ratio greater than 6, and 20% to investors with a DTI ratio greater than 7.
NECESSITY OR CURSE?
One has to ask if DTI’s were a necessary restriction for the Reserve Bank to put on our banks? After all, Loan to Value (LVR) restrictions already existed, which addressed the risk of the loaned amount outweighing the value of the property offered as security due to a decrease in the value of the property itself.
Additionally, banks have been very good as self-moniontoring themselves, implementing stress testing ratios on potential borrowers which seek to mitigate the risk of interest rates rising sharply and borrowers defaulting on loans due to an inability to meet an increased repayment amount.
Lastly, banks already had to comply with the Reserve Bank capital adequacy rules which require banks to hold a minimum amount of capital as a percentage of their risk-weighted assets. These rules address the risk of a bank’s exposure to housing market weaknesses.
POTENTIAL EFFECT ON PROPERTY MARKET
Whether you think DTI’s are necessary or not, they are likely to affect the property market. This is because borrowers will be constrained in the amount they can borrow by how much they earn. As most of us borrow to buy property, this link between income and borrowing will affect the speed and quantum of increases in house prices (eg: capital growth). That’s a good thing because their presence will likely prevent a housing bubble. Those trying to obtain a loan the size they need to buy a property however, may find the restrictions prohibitive.
SUMMARY
The above leads us back to the beginning of our article … just because interest rates are coming down, borrowing money won’t necessary be a walk in the park. Having up to date financial statements and information will be essential, something several of our clients have found recently when they’ve applied for loans. So, if you need to borrow funds, ensure you talk to us before you approach your bank. A conversation with your Lion Accountant can help you better manage your application and increase the chances of your bank roaring “Yes”.
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