Inflation down, new DTI and LVR easing

Now that we have all had a good break and the kids are going back to school, I thought I would update you on some interesting developments so far this year.

Inflation is falling

The CPI for the December 2023 quarter came in at 4.7% which is a drop from 5.6% and is in line with market expectations but this was mainly because of low imported inflation with domestic inflation remaining high. Whilst a drop in inflation is good news do not expect interest rates to start to fall in the next few months as 4.7% is still a long away from the Reserve Bank target range of 1 – 3%.  The Reserve Bank will also be keeping a very close eye on what is going in the Red Sea and elsewhere. Every ship that has to divert from the Suez to go around Africa adds 2 weeks and 2 million USD to the trip. There is also a drought in Panama causing low water levels in the Panama Canal restricting shipping volumes. International freights rates are going up and it’s the end consumer that will pay.

DTI

The Reserve of New Zealand intends to implement Debt to Income (DTI) restrictions later this year. What is a DTI?

The amount a bank can lend you is restricted to a factor of your total debt to your total income. Currently the Reserve Bank is proposing 6 times, that is your total debt can be no more than 6 times your current income for owner occupied lending and 7 times for property investors. For example, if you what to buy a house to live in and you earn $100,000 before tax then you can borrow $600,000 less any existing debt.

The Reserve Bank is also proposing to allow banks to lend 20% of their residential loans to owner-occupiers with a DTI greater than 6, and 20% to investors with a DTI of greater than 7.

As this is a proposal the details are still been worked out and as usual the devil will be in the detail as to what will be included as income and debt? Currently banks make an assessment of your income and this assessment does vary between banks, will this continue, will the Reserve Bank mandate what is included, or will it just be based on your tax return? Will things like student loans, family loans and business debt be included? Will banks still use the servicing test as well as the Reserve Bank DTI?

Banks are currently testing your ability to borrow based on a test interest rate of 8.5% to 9%. The proposed DTI is not all that different from the current servicing test and the vast majority of borrowers will sit inside the DTI level. When interest rates fall, DTI’s will become a limiting factor as you could pass the bank servicing test but fail the DTI ratio.

DTI have been introduced overseas and their aim is not to control house price growth, but to limit the risks to financial stability should a lot of people suffer reduced incomes and be forced to sell their property in a falling market. Historically mortgage defaults in New Zealand are low, I think currently less than 1.5% of banks total mortgage lending. You would think it would be a lot higher given the big jump in interest rates over the last couple of years. A lot of people including the banks and myself are questioning why they are needed at all!

LVR easing

The Reserve Bank has also announced an easing in the Loan to Value Ratio (LVR)

They have proposed to increase the amount of lending banks can do to customers with less than a 20% deposit from 15% of total lending to 20%.

This will give banks a little more space to take on low deposit borrowers which will be positive for first home buyers.