Will mortgage rules drive flood of buyers to riskier, more expensive loans?

Fears that new lending rules set to come into force next year will drive borrowers en masse to riskier, more expensive loans are unfounded, experts have told OneRoof.

With the Reserve Bank of New Zealand expected to implement debt-to-income ratios (DTIs) next year, concerns have been voiced that the new rules will disadvantage investors and marginal buyers.

Unlike loan-to-value ratios (LVRs), which limit the amount a person can borrow based on their deposit, or mortgage serviceability tests, which are centred around how much borrowers can afford to repay each month, DTIs cap loan sizes to a multiple of the borrower’s income.

The details of what the multiple would be are not yet clear, but the RBNZ set out the framework for DTIs in April and indicated they could be turned on as early as March next year.

There is likely to be some flexibility, with banks allowed to lend about 15% of their total mortgages outside of the DTI limit and exemptions for borrowers looking to purchase new-builds. However, some fear DTIs could further disadvantage marginal buyers, who already struggle to borrow with existing LVRs and serviceability tests, and put pressure on mum and dad investors to go with second-tier lenders, who are also exempt from the rules.

Opes Partners economist Ed McKnight says non-bank lenders offer opportunities for some borrowers. “The real pro is for borrowers who wouldn’t get money from a main bank, such as self-employed people.” Non-bank lenders sometimes allow such buyers to self-certify their income, says McKnight.

Traders are another group that may benefit from using second-tier lenders, as they often own properties for short periods of time. “ASB, BNZ or Westpac want to sell 30-year mortgages,” says McKnight, adding that investors also find there is flexibility in going with non-bank lenders, as they might want to do a 20-year interest only mortgage but find the main banks “will only go up to five years”.

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Sometimes first-home buyers take out non-bank loans for a year or two in the hope that the property goes up in value, which brings their LVR or income within the standard high-street bank lending levels. The risk, however, is that property values fall, and they’re stuck with the non-bank loan at a high interest rate, says McKnight. “Somebody buys their first home with a non-bank thinking, ‘In two to three years I will have paid off some [of the capital] and can go across the road to an ASB or to a Westpac’. But you have people who have purchased properties and prices have gone down 30%. They will be stuck paying that higher interest rate longer than they anticipated.”

McKnight doesn’t believe that current economic conditions will drive buyers to the non-bank lenders en masse. “One thing that is really important to remember about the DTIs is that there is a speed limit, where up to 15% of bank lending can be outside the framework. So effectively if the Reserve Bank comes out and says the DTI is seven, well up to 15% of bank lending can still be at an income ratio of above seven.”

Currently, says McKnight, less than 10% of lending would be affected by a DTI of seven. That means if the rules came into effect today, they would have very little impact.

“So even if a debt to income ratio came in, it would have almost no impact on what the banks could do. Some of the banks might say: ‘well, we're going to limit it anyway so that we don't get close to that limit’. That could potentially be the case.

“But I don't think we would see a wholesale change of behaviour, given that non-banks only make up between one and 2% of the mortgage market at the moment.”

Reserve Bank of New Zealand Governor Adrian Orr. The RBNZ has indicated it will implement DTIs next year. Photo / Jed Bradley

What’s more, says McKnight, the higher interest rates charged by non-bank lenders would be uneconomic for investors currently. “If somebody goes out and purchases an investment property at a 6% gross yield, your interest rate at a non-bank lender may be 8%, 9%, 10%.

“I think that at today's interest rates, most New Zealanders would self-regulate and say, ‘Well, I'm not going to purchase right now’.”

Other downsides that can make non-bank loans undesirable for potential borrowers include fees. There is often an application fee, then a set-up fee. Mortgage brokers charge fees for non-bank loans, says McKnight.

The other reason McKnight argues that fewer people than some expect might move to non-bank lenders is that it didn’t happen despite expectations when LVRs were brought in or when the Credit Contracts and Consumer Finance Act (CCCFA) was beefed up in December 2021.

There is this perception that if borrowers go to a non-bank lender it is going to be really easy to get the money, says David Cunningham, chief squirrel, at mortgage broker and lender Squirrel. But it’s not a bottomless pit. Funding can dry up, he says.

“With a [non-bank lender] there's always the funding constraint,” says Cunningham. “Whereas banks arguably have unlimited access to funding, the second-tier lenders rely on securitisation markets and that’s not something you just turn the tap on or off.”

Cunningham says DTIs are a tool for the Reserve Bank to control property prices as part of its mandate around financial stability. It’s one of a series of measures that have dampened demand from investors which include:

● Interest deductibility, for existing investment properties being phased out, making it “illogical” to borrow for an investment property unless it’s a new build, which is excluded.

● Banks assessing investment properties on a principal and interest basis currently, which doesn’t work for many investors.

● LVRs being higher for investors than homeowners

● Increases to interest rates driven by the Reserve Bank.

Cunningham agrees that non-bank lenders do not have the capacity to take on large numbers of loans. “It's not a deep market,” he says. If borrowers turned in great numbers to non-bank lenders, it would become very competitive and much much harder to find an alternative solution to a bank, he says.

Buyers who qualify for non-bank loans tend to be those with good capital, but lumpy income, says Cunningham. They may not pass muster under standard bank servicing tests for affordability, but do in fact have the money to pay.