Why getting a mortgage is set to get harder

Buyers could be facing new borrowing restrictions thanks to the runaway house prices.

Back in June, the Government gave the Reserve Bank of New Zealand the power to limit banks’ lending by using debt-to-income ratios .

The news barely created a ripple among first- home buyers, despite the fact that debt-to-income ratios could severely limit how much they would be able to buy

The Reserve Bank is currently in discussions with the banking and mortgage sector over the feasibility of implementing debt-to-income limits and other debt-servicing restrictions.

The Government agreed to add the restrictions to its toolkit on the condition that any implementation was designed to avoid impact, as much as possible, to first-home buyers.

Under debt-to-income ratios, the size of a home loan depends not on an applicant’s ability to repay the bank but on what they earn.

If, for example, an applicant’s household income is $100,000 and the debt to-income ratio is five, then they would have a maximum borrowing limit of $500,000.

Options to calculate household debt-to-income ratios include:

- A cap on the total amount you can borrow as a multiple of your income. That means a multiple such as 5 times, or 6 times, or 7 times income.

- A cap on the percentage of your income that can be allocated to servicing debt payments, maybe 30% or 40%.

- Increasing serviceability test rates. When the bank tests how much you can afford to borrow, the interest rate it uses is higher. Even if you're borrowing at 3%, for example, the bank tests you on 6%.

There are fears that debt-to-income ratios could lock some buyers out of the market, or prevent some homeowners from trading up to a better home.

But first home buyers shouldn't freak, says John Bolton, owner of Squirrel Mortgage Brokers. It is likely to hit investors worse than owner occupiers, he says.

"Most first home buyers sit between five and six times their income. It looks like the Reserve Bank will settle somewhere about 6."

Currently, 70% of first home buyers in Auckland are borrowing at a multiple of five or higher.

But Bolton says property investors could be hit the hardest by the ratios.

Rents are relatively low compared to house prices and investors could find that the huge multiples they're borrowing won't be allowed, he says.

Investors who are cross-collateralised (have more than one mortgage with the same bank), could find if they sell one property the bank would be legally entitled to take the full proceeds from the sale to reduce the debt-to-income ratio on the investor's overall debt.

Debt-to-income ratios aren't new. They're common overseas, and were a thing here in New Zealand decades ago.

Back in the 1980s, when interest rates were 20% or more, banks weren't willing to lend applicants more than their twice annual income. The current average income in 2021 of employed New Zealanders is $70,752. Under 1980s banking rules, Kiwis would have only been able to borrow $141,504.

Interest rates have declined since the 1980s making repayments cheaper.

Banks were keen to lend and competed with each other to offer more than their competitors to grow their market share. More important to the banks than debt-to-income ratios has been borrowers' ability to service a loan.

The banks test ability to repay on standard factors such as income and expenditure against the monthly repayments. They want to know that applicants will have enough money left over after mortgage repayments to pay living costs. With interest rates low generally buyers can afford to repay a higher loan than they would if rates rise.

Those lower interest rates have meant that home owners can afford higher repayments on larger loans.