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Measuring the impact of debt-to-income ratio's

Tags: Residential Residential Views

Is the use of debt-to-income ratio improving the resilience of New Zealand’s financial sector?


With our household debt amongst one of the highest in the developed world, use of a debt-to-income (DTI) ratio has long-been touted as a tool to improve the resilience of New Zealand’s financial sector. But just how would a DTI ratio affect you, asks Bayleys property reporter Katharina Charles?

Considered one of the ultimate weapons in the Reserve Bank of New Zealand’s (RBNZ) macroprudential arsenal, the introduction of a debt-to-income limit has been a controversial point of discussion which could yet be utilised to reinforce New Zealand’s financial stability and aid affordable housing targets.

As a simple calculation which offers insight into an individual’s ability to service debt, DTIs have been implemented successfully internationally (United Kingdom, Ireland) where high proportions of household lending have contributed to domestic financial vulnerability.

Following slow wage growth, falling interest rates and the relentless rise of New Zealand’s national housing market, in 2016 the RBNZ put the wheels in motion to implement a DTI tool which would have seen borrowers with a ratio exceeding five armed with less power to negotiate a mortgage.

Despite abandoning the idea after conducting a cost-benefit analysis which illustrated a possible 10,000 borrowers could be shut out of the housing market, with nine percent less sales and a loss of $260 million in Gross Domestic Product (GDP), today the RBNZ keeps a close eye on debt-to-income data, and has not conclusively ruled out using the tool in the future.

What is a DTI?

As a measure of personal finance, your debt-to-income (DTI) ratio contrasts the debt which you carry against your overall income.

For example, if I purchase a house at the national average as at January 2020 which is $615,000 with a 20 percent deposit, I will have a mortgage of $492,000.

Assuming my household income is the New Zealand national average of $102,613, then my debt-to-income ratio will be 4.8; which is just within the previous DTI proposal from the RBNZ.

The purpose of a DTI is two-fold; it is a good assessment of risk which shows a financial institution how able you are to service your existing debt, and offers insight into your ability to take on new debt.

The impact on households

For many households enforcing a debt-to-income ratio would have only a small impact, simply because the RBNZ has taken steps (e.g. loan-to-value restrictions) to ensure New Zealand’s banks are using similar calculations to assess individual suitability for loans under the Responsible Lending Code.

For house values and sale volumes it would be reasonable to expect that with the introduction of new policy there would be some degree of ‘wait-and-see’ adopted by both buyers and sellers, as observed following subsequent loan-to-value changes and the introduction of the bright-line test in 2015.

In its November 2019 Financial Stability Report, the RBNZ stated that since 2013 banks had reduced lending to borrowers with a DTI over five, and while ‘the concentration of household sector debt remains the largest single vulnerability of New Zealand’s financial system’, forecasts which expect interest rates will stay low for longer are viewed as improving the burden of debt for borrowers - ultimately reducing the risk to the financial system over time.

frastructure and new construction shapes the future of our region, it would appear that when considering the ultimate saleability of your biggest asset, the improvement of public spaces, municipal developments such as schooling, roading and hospitals as well as employment opportunities are key factors which increasingly hold influence over resale value in the evolving residential market place.

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