Debt to Income Ratio (DTI)

Recently there was an annoucement around Debt to Income Ratio (DTI), which sparked a bit of conversation. A number of people have asked what it means, the purpose and the impact. 

From 1 July 2024, banks will need to comply with new debt-to-income (DTI) restrictions, set by the Reserve Bank. DTI is a measure used by lenders to assess a borrower’s ability to meet their debt repayments. A DTI ratio looks at the amount of debt the borrower has, relative to their gross (before tax) income. 

What are the rules? Under the new DTI rules banks will be able to make a maximum of 20% of new owner occupier lending to borrowers with a DTI ratio over 6 and 20% of new investor lending to borrowers with a DTI ratio over 7.

This means you won't be impacted by the DTI rules if you borrow less than 6 times what your household earns before tax in a year as an owner occupier or 7 times your income as an investor.

Let's take an example of a family looking to buy their first home.

This family has an annual pre-tax income of $120,000,

Existing debt - $20,000.

Since they intend to occupy the property, a DTI threshold of 6 will apply.

This means they could borrow up to $600,000 before they are considered high DTI.

This is 6 times $100,000 (calculated as their yearly income, minus that $20,000 of existing debt.)

The bank could, of course, decide to lend more or less than this figure. And this is because for all borrowers, the bank decides how much to lend and will apply other lending rules and criteria too.

The main purpose is to limit the amount of debt a borrower can take on relative to their income. It will ensures that borrowers do not overextend themselves financially. 

So how will it impact everyone?  If people can’t borrow as much, house prices are less likely to rise quickly, especially during boom periods.This is because riskier high DTI lending tends to occur more during these times when interest rates are low.

The Reserve Bank’s new rules aim to moderate house price growth, making the housing market more consistent. This is beneficial for the market.The impact will not be felt currently as in most cases banks are not lending more than 5 - 5.5 times the income in any case. The impact will be felt when the interest rates reduce and households are more comfortable increasing their debt levels. The DTIs might slow some investors in that case. 

DTI restrictions won't apply to construction loans for new builds, bridging finance, Kāinga Ora loans, refinancing your mortgage and property remediation loans.

Got more questions on DTI? Just drop me an email on rajat@acemortgages.co.nz and I will help clarify.