Debt-to-income ratio limits might not have 'terribly big effects' on first home buyer sector, the RBNZ's macro-stability head tells; But it depends on how tool is calibrated; Cost-benefit analysis 'not easy'

By Alex Tarrant

Property investors are set to be in the firing line again if the Reserve Bank of New Zealand is allowed debt-to-income (DTI) ratio limits in its macro-prudential toolbox.

That might not come as a surprise. What might is, the Reserve Bank’s work on how the tool could impact other borrower classes.

“We don’t actually believe that a debt-to-income restriction would necessarily have terribly big effects on the first home buyer sector.”

That’s Bernard Hodgetts, the RBNZ’s Head of Macro-Financial Stability. I sat down with him this week after the Bank released its May Financial Stability Report.

Our discussion was rather timely. Finance Minister Steven Joyce currently has a DTI cost-benefit analysis written by the RBNZ sitting on his desk. We’re expecting it to be released in a week or so alongside a consultation paper on the measure.

Joyce earlier this year requested the work in a move seen by cynics as kicking the possibility of the RBNZ actually being able to restrict DTIs into touch until after the election.

Yes, we’ll get the analysis, but there’ll be consultation, re-drafting, a Governor switch…it’ll be a while before the bank’s ‘macro-pru’ toolbox is complete.

Basically, there were ‘worries’ that allowing DTIs would lead to a rush of frowning, first home buyers on the front page of the Herald in the lead up to 23 September.

With that in mind, I asked Hodgetts whether DTIs would serve to mostly ‘save owner-occupiers from themselves,’ where the loan-to-value ratio (LVR) limits had served to take the heat from investor demand.

“If anything, actually, it would tend to have less impact on particularly first home buyers, who typically don’t have as high a debt-to-income ratio as you might expect. The higher debt to income ratios tend to go to investors and potentially some more established owner-occupiers,” he replied.

“Although, again, that would come partly down to the choice of where you calibrate it.”

So, how exactly would the Bank calibrate a DTI tool?

We’ve seen talk about limiting debt to five times income over recent days, while a ‘speed limit’ would allow banks to lend, say, 15% of new loans at greater ratios.

“There’s nothing magical about 5, but 5 is getting up there on the debt-to-income ratio,” Hodgetts said. “If you look internationally, once you get to 4-5x range, it is starting to look pretty high.”

From an analytical perspective, it is always convenient to look at the proportion of debt to income ratios that are above 5 “because that’s putting you into the higher bracket.”

A key point: although there may have been a review of what might happen at 5x, the Bank isn’t out there requesting it be allowed a DTI tool that is set at 5 times. All it’s asking for is the tool – not the calibration.

The simpler the better

Another tack: Could the tool be calibrated to only be imposed on one borrower type – ie it only applies to investors, for example? Or first-home buyers?

“Potentially it could be,” Hodgetts said before adding, “but again, the lesson with loan-to-value restrictions – the insight we’ve drawn – is, the simpler you keep the design of the instruments, the better. There more exceptions or categories you create, the harder it becomes to actually implement.”

“But the good thing about a speed limit approach is, it does still provide banks with capacity to make loans to high debt to income borrowers if there’s good reason to. If they’ve perhaps got other financial strength, perhaps a high level of assets, for example, that they can potentially draw on,” he said.

“You wouldn’t want to block that kind of activity completely.”

Impact on the housing market

The big question then: Have you modelled what could happen to the housing market if you’re given the tool and use it at a given ratio and speed limit?

“That’s something that we certainly have modelled in the consultation paper,” Hodgetts said.

But he was coy on what exact modelling the Bank has done – we’ll find out all in good time as the consultation paper is released.

“There’s quite a comprehensive exercise there, to look at what would happen if a particular debt-to-income ratio restriction was imposed. It’s very much an illustrative approach, because we’re not proposing anything at this point,” Hodgetts said.

“But we are tracing through the impact in terms of the number of borrowers that would be affected, which kind of category of borrowers would be affected, and what we think the main costs and benefits would be from that.”

Cost-benefit analysis

Costs and benefits. How does one do a cost benefit analysis for a ‘macro’ tool? What falls under the ‘costs’ bracket? Can you provide nominal or quantitative costs and benefits or are we stuck on the qualitative side?

“Broadly the benefits of a debt-to-income tool would be around preserving financial resilience against a housing market downturn,” Hodgetts said.

“It’s not an easy exercise, but we’ve certainly tried to do that [in a quantitative way].”

“The main costs, I guess, relate to the fact that there will be some displacement of borrowers, potentially, from the market because they can’t borrow at the debt-to-income ratio that they want. So, you need to make some allowance for what that cost is,” he said.

“The other cost we would be contemplating is the short-term impact on economic activity of a debt-to-income ratio to the extent there’s less credit extended because you’ve effectively blocked the higher end of the distribution.

“There’s some potential cost in terms of short-term economic activity you’re effectively paying to get the benefits. So, the cost-benefit analysis is trying to weigh up those competing forces.”

The Bank has tried to bring as much data into the analysis as it could.

“But these are quite challenging cost-benefit analyses to do, given the nature of the kind of instrument we’re talking about, which is very much a macro kind of instrument. It’s not like doing a cost-benefit analysis on an aircraft wing falling off or something like that.”

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Homeowners need to be very careful in the current climate & possible DTIs if/when they sell their house and try to buy another house, as they may find the bank rules have tightened up & they will be re-evaluated on the.
banks own internal DTI, & LVR, & a full consumer credit check, rigorous new house valuation, etc.
In the light of this, it may be safer to stay in your current home & you are unlikely to be affected.

Thanks MortgageBelt, great advice. So you're saying in effect, that one could sell his house for say $800k and not be able to buy another house for $800k because the bank could say "we're not lending you as much as we have before"

Yes, you will expose yourself to a full evaluation. Of course, you could run the numbers past the bank first before selling to check. But you are vulnerable after selling - similar to 2009.
Likewise investors may be required to pay down debt after a sale.

If DTI will affect investors more than FHB - more the reason for national to avoid DTI and if not possible to avoid than to delay it as much as possible and this is exactly what they have been doing.

It is a shame that national government works only for the rich to get more rich and to remain in power and help rich need votes so throw some bribe just before election.

Need government that works for the betterment of all section of the society and not for the rich, by the rich, to the rich.

Haha and I'm thinking of the phrase "safe as houses". Market is already down with nearly half of the potential buyers gone with RBNZ's LVR restriction (some from the capital flight restrictions from China) and now they want to throw a critical blow to the market by introducing DTI ratio. We pay them exorbitant amount of money to keep the ship steady as she goes, not leave it until it's too late then do things to kill the market in hindsight. Their timing is soo off it's not funny, especially to the FHB who trusted the government and RBNZ to know what they are doing, saved hard for a deposit and bought a place within the last 6~10 months. If we can just let the free market decide the interest rates, as we should, why do we even need the central banks? They are the ons causing market distortions, booms and busts.

That's the direction the world is heading in with the rapid adoption of crypto-currencies. Look at the huge price increases in bitcoin and ethereum over the past year. People are waking up to the potential of these currencies as a hedge against economic collapse and meddling by reserve banks.

At the very least, it's prudent to have a minor portion of your investment portfolio diversified into crypto-currencies.

I just don't see a future in crypto-currencies. You are basically talking about individuals "creating" money.

Money is entirely dependent on trust - care to buy some "Noncents" Dollars off me? Didn't think so? So why on earth would anyone rely on bitcoin.

A currency at the end of the day is simply a means to transfer value from one party to another. I would say at the moment that the large crypto-networks are more tamper proof than any fiat currency, but the more minor cryptos are where the risk is.

There's a very, very large network constantly verifying transactions and isn't subject to central banks inflationary policies. I'm not saying that it's a definite that crypto will replace fiat currency, but diversifying a small part of a portfolio into them doesn't hurt.

plenty of companies and some banks now trading bitcoin, and since the change from the gold standard is not all money created with no asset backing

Nope, the recent exuberance in crytocurrencies is just Chinese Capital flight, it's not about a sudden change in investment sentiment and portent of future investment behaviour. The Chinese can't get the money out, but they can still buy bitcoin. If it wasn't bitcoin it would be something else. Crytocurrencies are just super easy.


Interesting argument. First you start off with a suggestion that intervention should have occurred earlier. Then you suggest that intervention is what causes the booms and busts. Which is it?

As for the recent FHB argument, if the intervention had occurred earlier, what of the FHB that bought just prior to the intervention? Someone will always draw the short stick in regards to becoming the greatest fool. It can be difficult to determine this in advance...

I dont think Stev used the word.. "should".

He is observing that the RBNZs' bad timing is one of the causes of the boom bust cycle.
I tend to agree with him. ( Central Banks are a part of the cause of boom bust cycles )

in regards to "timing" the worst time to bring in these kind of restrictions is at the TOP .... and the best time was at the beginning .... before the boom and over extension of borrowers.. started..

( So ..easy to see with hindsight..!! ...... but as stev says, dangerous to, act as if the hindsight decision, now , will make things right. ... not leave it until it's too late then do things to kill the market in hindsight.< i> )

Th e RBNZ will do this in the name of "financial Stability ... but it has the opposite effect when done too late. )

Agreed, constraints such as DTI should have been in place for all of the last decade. The reduction in interest rates of the last decade has been a very large contribution towards the housing bubble in NZ. The interest rate was a bit of rock/hard place thing, either one keeps the property values in check, or one has a good economy. Choose one... :) Allowing foreign capitol to invest without any meaningful safeguards was a rather stupid thing in my opinion. Not aggressively dashing highly leveraged speculators dreams early on was also a stupid thing in my opinion. But, the latter is most definitely not a part of the kiwi philosophy. Safe as houses indeed.

I agree with you on interest rates Stev-O but when it comes to who's to blame for this mess I lay the blame fairly and squarely at the door of the National Government and in particular John Key. Ever wondered why he quit? I think he could see the steep descent coming on the other side of the hill.

Key had alot of popular support and was trusted by a significant proportion of the population for his "financial acumen". He was the guy who denied there was any crisis and never warned people to be wary of this market. So the sheeple just borrowed and binged - thinking "it must be OK if John says so". The first person to sound any notes of caution to borrowers was Joyce earlier this year after Key's resignation.

The RBNZ has a very narrow remit to keep inflation within a range. The government is in a far more powerful position to be able to influence the market through taxation, immigration and overseas investment policy.

They have done nothing - just sat on their hands and watched this bubble blow bigger and bigger and bigger - shame on them.

They really don’t know what to do, now that they suspect others have started to realize they really don’t know what they are doing. How about now with 4.3% “unemployment” and not even the hint of signs of wage inflation? The lower that rate goes without inflation the more exposed their ignorance, and yet the more they harden and cling to their already untenable philosophy. There is an enormous volume of literature from the 2000’s that “diagnosed” what went wrong with the Bank of Japan, but instead that provided a template for what the(Fed) or ECB would do anyway. A more reasonable and objective assessment in 2017 would be that the Bank of Japan had no idea how to “vanquish” deflation, and neither did Bernanke. It is why, and how, economists became nothing more than statisticians, steeped in mathematics without the foggiest idea what goes on in an economy.

Should remind you that the Governor of the RBNZ wanted to use DTI couple of years ago and was flatly rejected by Key and English

Still haven't actually seen an answer on what happens with people who are renewing theif fixed mortgage and are now above the newly introduced DTI's?

Presumably, in the same way other macro-prudential tools (e.g. LVR restrictions) don't apply to backbook, this wouldn't either. However, if more capital is required to be held to mitigate the risk, then one could assume increased prices.

A simple renewal with no extra borrowing, and no other issues, would be unlikely to trigger a DTI evaluation.

Would be easier just to require banks to improve their capital ratios; then they will reduce dodgy lending.

Banks clearly can't be trusted not to support dodgy lending and home owners also can't be trusted not to take on too much debt. I think DTI's are a marvellous idea. People absolutely need to be protected from themselves.
15x incomes? Muppets.

If homeowners can't be trusted and Banks can't be trusted - why on earth would you trust Government and the RBNZ?

Good point. The macroprudential tools such as DTI and LVR limits are just patch-ups and bodges to fix inadequate regulation on bank capital, particularly the inadequate risk weightings on home lending.

Let's not forget that DTI is a Gross Debt figure ie: It's not just a mortgage debt of an individual that's being evaluated, and all other debts, like the credit card, comes into play as well. For credit cards, for instance, it's not the total amount outstanding that they take into account, but the Limit Available; and that is assessed much more harshly than a mortgage (it's an unsecured loan, not assessed at 5:1 but possibly, say, 2:1).

Auckland control tower this is Kiwibird Housing 1 very heavy, we have a small problem and are returning immediately to Auckland. Kiwibird Housing 1 what is the nature of your problem Kiwibird Housing 1 : we have lost a wing , but Bernie from the RBNZ is with us and assures us he can fix the problem. Control: How will Bernie fix the problem, he is an expert in macro financial stability, not flight stability. Kiwibird Housing: Bernie says he has a toolbox from Bill and will reattach the wing after we land. He has researched the matter with Joyce : Control: which approach do you prefer. : Kiwibird Housing1 Bernie says we will come straight down any where is fine.

Okay I'm confused because the major banks have always based their mortgage lending on what your earning and therefore able to repay. Moving this slider up and down just means it will either cut you out of the market at one end or be financially suicidal for the bank at the other. The correct and "Safe" setting somewhere in the middle would realistically still eliminate most FHB from the market so what really changes ? My BIG question is, which banks have basically been financially irresponsible that we need these measures introduced in the first place ? No one I know managed to get a mortgage beyond their means of paying it back so what happened ?

"...the major banks have always based their mortgage lending on what your earning and therefore able to repay"
Not wholly right. In 2007 I had a Term Deposit maturing and toddled along to BNZ to ask for the alternatives to rolling it over. The answer (and what surprised me!) was "Look, We can lend you $X - (which was 9 times the value of the maturity) - as long as you use the funds to buy Y number of houses to rent out". Income didn't really come into it, because the amount of rent came nowhere near to covering the cost of the interest payments, even after allowing for the usual tax advantages..... It was all about 'come up with 10%' in those days, and the rest was up to you. That strategy looks good today, but would have looked nasty in 2009 as the full horrors of the GFC hit......

If you pay too much for anything and then try to sell it you meet resistance Aucklanders will face that now.
There used to be a great deal of resistance when I would go to banks and try and borrow say 450K or 625K and then everything changed. They learned they would see their money back. The problem evaporated.
I could borrow what I wished. NZ actually is a far easier place to borrow than in the US where it usually takes around 45 days to get a mortgage approved !! NZ I love you.

"...the benefits of a debt-to-income tool would be around preserving financial resilience against a housing market downturn"
Would be ironic if DTI precipitated the downturn

I agree that the best time to do DTIs is when the market is stable, but sadly some people need saving from themselves so to implement now will stop adding more into a potential negative equity situation but it should be a gradual implementation.

unfortunately it looks like many with high DTIs are going to find out the hard way