With concerns about whether newly reinstated loan-to-value restrictions can cool the housing market, debt-to-income limits are attracting attention as a potential solution. Sam Sachdeva investigates.
According to a new Ipsos survey, 60 percent of New Zealanders now rate housing as the biggest issue facing the country - the highest mark since the market research firm began polling Kiwis in 2018.
That is little surprise, given the rapid upwards spiral in prices in recent months, and with growing political and public pressure it is also hardly a shock that officials are scrambling around for a near-term solution.
The reintroduction this month of loan-to-value restrictions, or LVRs, could take some of the heat out of the market, but Kiwibank economists have warned this month the restrictions “may not be having as much of an impact on investor activity as previously thought”.
That has led to some promoting a different course of alphabet soup: DTIs, or debt-to-income restrictions, which restrict the amount of lending banks can provide to house buyers whose total debts outstrip their income by a set ratio (five is the number which has been used in discussions here).
In December, Reserve Bank governor Adrian Orr formally asked Finance Minister Grant Robertson for the ability to put such a tool in place - a request still under consideration.
The theory is that those high-risk borrowers present a greater risk to financial stability in the event of a market downturn, making it wise to reduce exposure, as Jeremy Couchman, a senior economist at Kiwibank, tells Newsroom.
Couchman says with mortgage rates expected to rise next year, any borrowers whose debt-to-income levels are on the high side could find any increase “really start to bite on them financially”.
“If you look internationally, at countries in the past that have had very high levels of debt relative to income, they have been followed by significant economic downturns.
“And when you have a downturn that's driven by a huge market correction in the housing market, those recessions tend to be much more drawn out than other types, so they can be hugely damaging.”
Data from the Reserve Bank’s most recent Financial Stability Report last November shows a marked increase in such high-risk mortgage lending.
Owner-occupier lending with a debt-to-income ratio above five and a loan-to-value ratio greater than 70 percent rose from 21.8 percent in September 2017 to 27.7 percent in September 2020.
The same lending to investors more than tripled over the same period, rising from 8.3 percent to 26.1 percent.
While the bank notes that debt serviceability rates have in fact improved over the last two years due to a drop in mortgage rates, that may not remain the case.
Couchman says with mortgage rates expected to rise next year, any borrowers whose debt-to-income levels are on the high side could find any increase “really start to bite on them financially”.
While a debt-to-income tool is primarily aimed at financial stability, it would also likely lead to a slower rate of growth in the housing market.
Sense Partners economist Shamubeel Eaqub tells Newsroom a limit could help to “stymie that flow of credit to people who can borrow very large sums of money” and bid up the price of homes - but not without some flow-on effects for potential first-home buyers already struggling to scrape together a deposit.
“The equity issues are really quite big, so you know, the same thing that we have now: if you've got the bank of mum and dad, then you're still going to be fine, they’ve just got to help out a bit more.”
More broadly, Eaqub says the measure could help to reverse the decades-long flow of credit into mortgages, due to the lower risk weighting, and into more productive parts of the economy.
This isn’t the first time the Reserve Bank has asked for the debt-to-income tool to be introduced to its toolkit, of course.
In 2016, incumbent bank governor Graeme Wheeler asked the National government for the ability to apply such restrictions.
But in 2017, when Steven Joyce became Finance Minister following Bill English’s ascent to the prime ministership, Joyce asked the bank to carry out a full cost-benefit analysis - kicking the work into touch, as Bernard Hickey put it at the time.
In an email to Newsroom now, Joyce disputes any suggestion he put the work on ice, saying he simply asked the Reserve Bank to consult on its plan to “bring forward all the different views” at a time when house price growth had flattened out.
“In the past RBNZ had sometimes been given the new tool first and then they consulted on it. I simply wanted it the other way around as I thought that was a better process (and there was no immediate urgency over the few months it would take),” Joyce said.
In fairness, the Labour opposition was hardly enthusiastic at the time either: Robertson, as finance spokesman, issued a press release calling on National to “push back” on Wheeler’s proposal.
“You can't say, ‘I'm going to restrict credit, and at the same time, we're going to increase credit to the group that might be most vulnerable to an economic shock or an increase in interest rates for a fall in house prices’.”
That political pushback is due in large part to the fears that such a broadly targeted debt measure would effectively shut first-home buyers out of the market
In its 2017 consultation document, the Reserve Bank raised a number of possible options to protect first home buyers, such as an exemption for owner-occupier purchases below a certain price cap or a higher debt-to-income ratio for first home buyers.
It also proposed an exemption, as with LVRs, for new builds so as to not act as an inadvertent handbrake on construction.
But Eaqub argues creating too large a carveout for those looking to get into their own home for the first time, while putting the leash on investors, may cut against the financial stability goal of a debt-to-income tool.
“You can't say, ‘I'm going to restrict credit, and at the same time, we're going to increase credit to the group that might be most vulnerable to an economic shock or an increase in interest rates for a fall in house prices’.”
Couchman agrees that debt-to-income ratios are often higher for first-time buyers given their lower incomes, but says international evidence suggests it is investors who make up the riskiest part of the market in a crisis.
“When you have downturns and for example, banks are saying, ‘You have to front up or we're going to default on the loan’...people are more willing to let go of investment properties rather than their own home.”
While it could take some work to figure out how to accurately record incomes, banks have been collecting greater debt-to-income data in recent years.
Couchman says there would also likely need to be regional debt ratios rather than a one-size-fits-all approach, given the vast differences in house prices around the country.
“If you apply a five or six times [ratio] across the country, you're really going to penalise places like Auckland, Otago Lake District...which may actually create a lot more adverse effects than you probably want to see.”
At the time of the 2017 consultation, critics also argued debt-to-income ratios were not a good measure of likelihood to default and thus a crude tool, with limited international evidence about their effectiveness - concerns which would likely need to be addressed if they were to be imposed now.
No magic bullet
In its 2017 cost-benefit analysis, the Reserve Bank estimated around 2000 owner-occupiers and 9000 investors could be prevented from purchasing each year as a result of a debt-to-income limit, leading to a two to five percent drop in house prices and credit growth - numbers that would, barring tweaks to its original plan, almost certainly be higher now given the inflation in the housing market since then.
Those sorts of numbers may give Cabinet ministers pause for thought about whether they really want to pull the trigger on such a significant measure.
But as Eaqub points out, with house prices getting out of reach for many aspiring buyers, a somewhat painful correction for some may be necessary for the good of the wider population.
“It's not really the access to lending that's the problem, right? It's that house prices are so expensive.
“There'll be people at the margin who will get affected, so there's always the border effect, but you can't make policy on the basis of borders.”
Whether or not Robertson agrees to give the Reserve Bank the tools it wants - and whether or not Orr chooses to use them - Eaqub is clear it will not be a magic bullet.
“The thing with these kinds of macroprudential tools is that no one policy is going to do it, you're going to have to use a whole bunch of them together.
“The way to think about it is any one of these tools is not that effective on its own - but all of these tools together can be very powerful.”
