DTIs will start affecting borrowers by the middle of next year

By the second quarter of next year, CoreLogic chief economist Kelvin Davidson reckons they are going to part of the conversation as interest rates drop.

“Borrowers are not going to wake up one day and interest rates have fallen to ‘x percent’ and nobody can borrow. It is not going to be like that.

“It will be more part of a conversation when a borrower is at the bank or in front of a mortgage adviser and will be told they are pushing the DTI limits. It might not stop them getting a loan but it becomes a factor.”

Not many mortgages are now being loaned at high DTI numbers. Reserve Bank data show less than 5% of all loans are currently being done at high DTIs, specifically 2% in September for first home buyers and 3% for investors.

Even though banks can do 20% of lending to owner-occupiers who are buying existing properties at a DTI >6 and for investors at a DTI>7, with new builds exempt, the numbers are held down by their elevated serviceability test rates of between 7.5-8%.

While the level of these test rates is opaque, they allow banks to ration credit. What stems from that as interest rates come down is a higher share of lending going out at a higher DTI, Davidson says.

“The word on the street is when banks’ test rates get to about 7% that is where DTIs become a bigger consideration.”

He says if mortgage interest rates fall between 0.25% and 0.75% next year and test rates come back, DTIs will become difficult for many borrowers, but particularly investors.

Some borrowers will struggle to get a loan and after a period others will be blocked out by the DTIs.

New builds are exempt and will become a clear option for some borrowers. Investors are already in that market, Davidson says 

“When the property market peaked in 2021 it was mainly investors who borrowed at high DTIs, and it will be the same this time.

“There will be some trade-offs in the sense that when interest rates drop the cashflow on their rental/s looks better. While they might still be topping up the mortgage they can handle it better. On the other hand, they might not be able to get a further loan to buy another property.”

From a wider perspective, Davidson says it is the mum and dad investors with one or two properties who provide most of the country’s rental houses and if they find they can’t buy more property as readily that could become a talking point around the housing sector and economy.

After the pandemic there was a massive upswing of 45% in house prices. In another housing boom DTIs will prevent this. “DTIs push against a big increase in house prices, but it does mean tricky decisions for individuals.”

At the same time, Davidson says it appears some borrowers don’t want or need big loans, given national property values are still 18% below their recent pandemic peak.

He says there are so many moving parts to DTIs. As incomes rise that helps push back against the effect of DTIs and people don’t need to borrow as much, but wage rises are expected to be on the slimmer side next year.

DTIs are a significant shift in the lending landscape, by tying house prices more closely to incomes over the long term (but not preventing phases of faster growth altogether) and slowing down the rate that investors can build a portfolio of properties. As part of that, some buyers may well find that their ability to purchase a property is reduced or delayed.

He says it will take some time until the banks’ DTI speed limits take effect because there is too much headroom now, but in a falling interest rate environment conversations could start in April/May.

“To be fair, in expensive markets (with high ratios of median house prices to median income) such as Queenstown, Tauranga, Nelson, or Auckland, there’s a case for thinking that some would-be buyers could be impacted by the DTIs.”

But Davidson says he would be wary of taking that argument too far. Successful buyers tend to earn more than the median income, and in the case of first home buyers (FHBs) can often buy a property cheaper than the median price. “That willingness to compromise and to ‘find a way’ is a key reason why FHBs are running at record-high market shares around many parts of the country.”

He says to the extent that DTIs do in fact dampen the housing cycle, they’ll help affordability to stay in a more comfortable range over the long term, thereby actually helping would-be buyers (although ultimately a key factor here is still trying to keep physical housing supply growth ahead of demand).

Although DTIs aren’t binding yet, they may well become a much greater consideration for banks and borrowers by the middle of next year. It’s possible some would-be buyers will struggle to get a loan as a result, but housing affordability is likely to be kept more in check over the long term.