- Hi, it's Connie from Prosperity Finance,
sharing the best financial tips
so that you can be more successful
with achieving your financial goals.
Today, I'm going to talk about DTI, debt to income ratio.
It could be a quite new concept to you,
or you probably heard from the media many times so far.
Now, the reason I want to discuss this topic today
is because Reserve Bank has finally got a green light
from the finance minister, Grant Robertson
to have DTI as a tool to control financial stability.
Just like LVR or interests only rule, et cetera.
If Reserve Bank have this tool in place,
then they can enforce banks to implement and monitor
that tool, and make sure that people can only borrow
certain amounts to control the financial stability.
Indeed, it's good for the banking system,
but if you are investor,
you're looking to grow your property portfolio,
it's indeed a very bad news.
Now, in my opinion I think it's kind of overkill
because banks are already really tightened
their lending policy.
Now, despite the interest rates, it's only sub two percent,
but some banks was even using 7.25% as test interest rates,
to test if you can afford the loan
at that level of interest.
So, while you have this high test rates
and very low LVR ratio, I think DTI is just unnecessary.
Now Reserve Bank they just want to have these tool in place.
They didn't say they're going to use it immediately.
I think for now, it's still early stage
because recently, government has introduced some policies
to reduce the housing market heat, right?
So it really depends on how it goes, right?
They may not need to use a DTI immediately.
And also the DTI is not finalized yet
in terms of how the income is measured,
how the ratio is defined
and what other exemption is still unknown.
So we don't really know at this stage.
It's going to take at least six months for Reserve Bank
to finalize everything.
And then they use that tool if they see fit.
So we don't know how long it's going to take,
but it looks like at least we have another six months.
Now, even though we can't control the policy,
we can't stop Reserve Bank having that tool
in their tool box.
But at least we can start reviewing our strategy
and see what we can do to minimize the impact.
Therefore today I'm going to talk to you
about this DTI thing and see who's impacted,
what kind of impact looks like and what are the strategy.
Now at the moment ASB already have a DTI ratio
as part of their lending policy.
In fact, it's already started last year
about, yeah this time last year,
so after COVID in New Zealand.
So currently in terms of income, for job income
they use the net income,
for rental income and borrow income,
they use gross income.
And then they set the maximum debt
to seven times of the total income.
So if you only bank with ASB and you are investors,
you probably already reached the borrowing ceiling.
But in fact,
other banks have not had this policy in place.
They may introduce that policy,
but once the Reserve Bank set the rule
and say, banks, you have to use it, then they had to use it.
But at the moment ASB voluntarily use this, okay?
So just give you example,
what the DTI could look like from ASB example.
Now, so who's going to impact by this thing?
So it looks like it will be investors because at the moment,
if you just want to borrow money to buy a home,
it's not a issue because bank already have servicing
calculation to limit your borrowing capacity.
It will be within seven times.
So you won't breach the DTI.
However, if you are investors, it's more likely
that if the DTI is set as seven times
you won't be able to buy any more,
unless your other income your job income for example,
at really high level.
So it really affect people who just start up building
their property portfolio.
Want to buy a few property from now?
Now, because the property already is so expensive,
the rental yield is so low.
It's very hard to borrow with the DTI measurements.
Also for people who are looking to buy in the area
that's already very expensive, like Auckland, Wellington,
Queenstown and Tauranga.
These places, their average prices
probably a mill or over a mill.
So for the similar reason, the rental yields is really low.
So you won't be able to borrow anymore
if the DTI become effective.
Now, this is just a high level.
Now, today, I actually made up example to show you,
exactly how that impact look like.
So let me share this example with you.
Okay, so on the left hand side,
we assume the purchase price is 950K.
So you're buying a rental property for 950K.
Now I have some assumptions.
The loan term is set for 30 years
and the test interest rate is 6%.
at the moment, bank use 5.0% to 7.25%
as test interest rates for a borrowing capacity.
So let's use 6% as average.
And then let's assume you borrow 100% of the purchase price.
This is not the LVR, LVR is the loan to value ratio.
The value means the security value.
Here I'm just talking about the purchase price.
So you borrow 950K.
Now the next assumption is about the rental discount.
Now with the bank lending policy at the moment,
they set the scale at 75% to 80%,
the other 20-25% is actually take care of the vacancies,
the other operating expenses like insurance rates,
fix water charge, property management, et cetera.
So they don't require you to have a financial statements
to approve your expenses.
They simply take out 25% to cover these other cost
or reduce the rents if you're not fully rented
for the whole year.
Now we also assume the DTI is set at seven times.
So now move to the middle parts.
The middle parts is the servicing calculation
that banks already have at the moment.
If the loan requires 950K,
if we want just to use the rental income,
the new rental to cover the servicing requirements,
that means we don't rely on our job income
or any other income, just the rent, the new rent income.
Then that monthly net rent has to be $5,696.
So if we convert it to a weekly gross income,
that means you have to rent it for $1,753.
This is for a property you can purchase for 950K.
So it looks like very impossible
to have this high rental yield.
Now, if we work out the gross rental yield it's 99.59%.
Now just put into context.
I live in Auckland, I think in Auckland
the average gross rental yield probably less than 4%
is around 3.5% on average.
So, but the banks require the gross rental yield
of 9.59%.
So that means in order to buy a rental property,
you need to have this rental yield
or you have to have other income from your job income,
from your existing rental to cover
to supplement that rental yield, okay?
So we can see that yield is already very high.
That's why people have a ceiling.
You probably buy one or two or maybe three
if you have a high job income.
Then you get to the ceiling stage,
which means you can't borrow anymore.
People used to asked me from time to time
why some people can have really big property portfolio?
Well, the reason, so firstly, a few years back,
the property are not this expensive.
Now, your salary compared to the house price
have a better ratio than now.
And also the rent is increased,
not at the same pace as the house price increase.
So it's getting harder and harder to borrow
because the servicing part
is increasing at a reduced speed as the house price, okay?
And also people who really have a good
big portfolio, they don't just buy the rental
and then just rent it out.
They always do something about their property.
They probably renovated it, they probably
add another room or have another dwelling.
So they always try to improve the cashflow
and make it as close
as to the bank required yield.
So that's why people can't buy as many property
as past because of these factors.
Now, if the DTI introduce let's look at the right-hand side.
In order to borrow 950K the rent has to be $2,610.
And the gross rental yield is 14.29%.
it's really ridiculous,
even at 9% is impossible.
If we have to find a something at 14%
it's definitely impossible.
All right.
So it just means not really borrow anymore
once the DTI implements.
So what are the impact?
Firstly, like we just saw you can't really borrow more
if you want to buy a rental property.
And secondly, if you have interest only loan
and has come to the end of the interest only term,
you want to extend for another few years,
bank will do a full review on you
and they will consider the DTI if DTI is in place.
Also if you trying to partial discharge a property,
what a partial discharge means is
let's say you have multiple property
secured to the same bank,
and you want to take one property away from that bank,
maybe because you want to sell that property
or you want to refinance, but you still have other security
or other loans with that bank.
So you're doing partial discharge.
When you do a partial discharge,
bank also do full credit review.
So they will review your DTI as well.
So if DTI is in place,
the partial discharge could be an issue.
So it affects your borrowing capacity,
affects the interest only in your over.
It also affects partial discharge.
So what are the strategies available right now?
Firstly, I would recommend if you are thinking
about buying more rental property, buy them now.
I know with the current bank policy for UMI,
it's already very hard, set at 9% gross yield.
But at least you have other income to subsidize that yield.
That means it's still possible if you buy now.
If you are with the right structure, with the right banks,
it is definitely possible.
But when the DTI put in place,
it just makes even harder for the servicing ability.
So buy now.
Now, the second point I want to make
or second strategy is focusing on the cashflow.
We know the end game for property investments
is the capital growth.
We want to build wealth through property.
So we want that equity build up over time.
However, in order to buy the property,
you need to get enough cashflow in order to borrow more.
So for cashflow, you focus on the job incomes.
So you probably the single income earner.
So see if you can have two income earners.
Or, change another job with a high income.
I know it's not easy,
but if you want to have more rental property,
think about this angle
and see if you can improve your job income.
Now for your rental properties,
try to improve the cashflow by adding value,
by buying at a higher rental yield property.
So the cashflow is very critical.
Now the last strategy I want to make it is not new strategy
'cause I've been talking about in different videos.
It's about splitting banks, why?
When you're splitting banks,
you minimize the risk of having a negative lending policy.
Now, what we noticed is over the last few years,
is a bank have different policy from one to the other.
It's not the same.
So if one bank introduced lending policy
that have adverse impact on your borrowing capacity,
the other bank might work.
But if you have everything with one bank,
you just stuck there, right?
And also with the partial discharge,
if you just have one property with one bank,
there's no partial discharge required
because you simply pay off the loan
for that particular property.
There's no other security within the same bank.
So split bank, as much as you can.
That'll definitely help you.
So in summary, the DTI is inevitable
but you still have a time.
So take advantage of for the time being
and buy now, focus on cashflow and review your structure
in splitting bank if you can.
For your personal situation,
I would recommend once you get customised advice,
get in touch with us.
We will let you know how to do it in your spoon situation.
So hope you find this video useful.
If you have any question, feel free to drop us an email,
leave a comments.
So we really want to hear what your question
so that we can answer directly.
And also let more people benefit from the answer as well.
So thank you so much for your time,
I will see you next time.
Bye-bye