Thursday, May 30, 2024

Kerre Woodham: Debt-to-income restrictions aren't a bad idea

Fundamentally, I would have thought that limiting debt-to-income is a good idea.

The debt-to-income ratio is the ratio of your total debt —mortgage credit cards, child support payments, hire, purchase, and the like— relative to your total pre-tax income. So, for example, if you have a total debt of $500,000 and your total gross income is $80,000, your debt-to-income ratio is 6.25. It means your total debt is 6.25 of your total gross income. So, as I say, to estimate your debt-to-income ratio, start by adding up all your debt payments, any large fixed payments you simply can't afford, and divide them by your pre-tax income.

From July the 1st the Reserve Bank will put in place new debt-to-income ratio restrictions on the banks. That means they will have to limit the volume of high debt-to-income lending that they can extend. So, up to 20% of new loans to owner occupiers can be issued to borrowers with a DTI ratio of more than 6. Only up to 20%. Anything beyond that, it has to be below 6. Up to 20% of new loans to investors could be allocated to borrowers with a debt-to-income ratio above 7, the rest have to be below.

However, just to throw some more letters into the mix, the bank will ease the loan-to-value ratio restrictions (LVR's) and that means banks can lend on more low deposit loans. So, before you had to have a high deposit before you could get into a house, now they're saying you could have a lower deposit, but your debt-to-income ratio will be the figure that is scrutinised.

The Reserve Bank argues that by adjusting these levers it's managing different types of risk to the financial system. With LVR restrictions, it's targeting default risks from undercapitalised loans where you didn't have enough in there and now your debt is so high you can't pay it, while DTIs address default risks from income insufficiency. So, you've just got too much debt for your income to sustain, there's your pay packet groaning under the strain of all the debt repayments, and they're saying that they're going to help you by not letting you get into that predicament.

However, some people see this as a very bad thing, including property commentator Ashley Church, who pulled no punches when he was discussing the new restrictions with Mike Hosking this morning.

“Oh, terrible. And in fact, I was thinking the other day I must do something for the release on this. This will be the single most stupid move that the Reserve Bank has ever made. And I don't make that statement lightly. He’s made some stupid moves. He's made some stupid ones. The LVR restrictions a few years ago were pretty bad, this is worse. If I was going to make a prediction on this, it will be reversed within three years. It will completely screw up the property market at a time when we should actually be looking for it to recover from what it's been for over the last three or four years.”

Now Ashley, of course, is a property commentator and you know he's in the business of property and wants to see it booming. But it seems the Reserve Bank is trying to stop just that. Trying to stop the boom and bust housing cycle, so that you can only take on a debt if you can afford to repay it. I mean, there's good debt and bad debt. HP is probably bad debt; you would consider that bad debt. AfterPay is bad debt. Good debt is taking on, say, a home in which you can live. It doesn't have to be as an investment, but if you are renting, then a lot of people see that as just empty money, dead money. If you are putting that into a home you can call your own, many see that as good money. So, it might be the biggest debt you ever have, but it's considered good debt as opposed to credit card debt or AfterPay debt.

Now the Reserve Bank, Ashley Church said, has made some very stupid decisions and by trying to tinker with the economy. You know, we're in the position we are in where we've got high interest rates and unemployment is starting to rise and that, it appears, is what the Reserve Bank wants. They're trying to engineer a recession so that the spending stops, demand stops, and then the interest rates can come down, and it means those with mortgages can breathe a little easier.

But surely it is a good thing if the property market is a lot more even, a lot more level? We don't want booms and busts, nobody does. Well, some people make a fortune out of them, but the majority do not, and nobody wants more debt than they can manage. There is nothing worse than that feeling of being strangled or crushed by debt. Borrowing from Peter to pay Paul. Having to make decisions month on month about what you're going to fix first or what you're going to pay off first. Trying to keep the slavering wolves from the door.

And there is the capacity to be able to borrow more by lowering your debt-to-income ratio by paying off bad debt. You know, if you pay off your student loan, you can borrow more. If you get rid of the credit card and pay that off, you will be able to borrow more.

Ashley, as I say, pulled no punches, but then he has interests vested in the property market. I mean at first reading; I see this is not a bad idea. You know, there are a lot of people who are crushed by debt. By restricting how much they can borrow, surely that's in everybody's best interests, including the banks.

So I'd very much like to hear from you on this one and if it affects you in terms of your plans for home ownership. By having a lower deposit and having a reasonably good debt-to-income ratio, are you going to be able to get into a house? But if you're only earning, say $80,000, can you get a house for what the bank is willing to lend you on your debt-to-income ratio?

Kerre McIvor, is a journalist, radio presenter, author and columnist. Currently hosts the Kerre Woodham mornings show on Newstalk ZB - where this article was sourced.

1 comment:

Robert Arthur said...

Debt to income is fine when employment is very secure but now a nonsense for very many.