DTIs on investment property don’t make sense

As experts expect property prices to rise between 5-10% this year, the biggest dampener will be debt-to-income (DTI) ratios if introduced towards the middle of the year.

Thursday, January 18th 2024, 11:31AM

by Sally Lindsay

While property values last year closed on a strong note with three consecutive rises, any recovery this year could undershoot expectations and prove a little underwhelming, Kelvin Davidson, CoreLogic’s chief economist says.

“A lot hinges on how mortgage rates move and how any fall is counteracted by tighter lending restrictions from the Reserve Bank, such as DTIs.”

Finance Minister Nicola Willis and ACT leader David Seymour have said in the past they are not in favour of them but Kris Pedersen, who owns a mortgage advising business, believes they will be introduced although he is not a big fan.

He believes the Reserve Bank will keep the ratios at a high setting – probably about seven times income. “They won’t initially have any effect on the overall housing market because banks’ test rates are high and act as a stricter measure than DTIs right now. Maybe in a couple of years’ time when test rates have dropped the market will see their effect.”

He is particularly critical of the RBNZ’s decision to apply them to all lending. “In England and Ireland, DTIs are only applied to owner-occupied housing.

“If they are applied to all lending here it doesn’t make sense. For example, if a mortgage holder can borrow seven times their income and the formula includes taking into account what they spend on living costs, is that going to apply to investment property as well?

“That formula is fine for an owner-occupied property, but for an investment property it doesn’t make sense as it will include a separate set of living expenses which don’t apply.”

Five years ago TailRisk Economics principal Ian Harrison analysed the RBNZ’s justification and evidence for DTIs and was particularly disparaging of their application to investor loans.

“The DTI measure assumes that when investors purchase new properties, their living expenses increase – but this simply does not make sense.

“The effect of the policy would be to impose an effective LVR limit as low as 30% on professional investors. Yet no other country has imposed DTI restrictions on investor loans.

“This would generate perversely restrictive outcomes for this group.”

Pedersen says mortgage holders don’t go broke on equity, they go broke on cash flow. Theoretically an investor can hold a mortgage that is higher than the property is worth.

“If the investor has enough cash flow they can survive but an owner-occupier would find it difficult so DTIs, in some ways, because they focus on cashflow do make sense. I just don’t think they should be applied to property investment.”

Davidson says it's always worth being mindful of the role of psychology in the housing market, and the scope for sentiment to overtake the fundamentals.

“Investors' moods seem to have perked up lately off the back of the change of government. But with significant cashflow top-ups out of other income still required on a typical investment property purchase, that positive mood may not translate into much extra buying.”

Davidson anticipates sales activity to rise by about 10% this year, which is reasonable growth, but from a low base. Meanwhile, he says national property values could rise by about 5%.

Tags: DTIs