Key factors in residential lending: First home, next home, and investment properties

Whether it’s your first, another home or investment property, Infinance has the facilities with banks and non-bank lenders to take you there. With many moving parts and in the interests of keeping it simple we’ll brush over the main points and provide references for more in depth information rather than re-invent the wheel.

UMI and LVR

There are two main factors at work to determine the amount you can borrow, the first and foremost being Uncommitted Monthly Income ( UMI ) and the second Loan to Value Ratio ( LVR ).

Uncommitted Monthly Income ( UMI )
UMI is all about how much money is left at the end of the month to service a mortgage.

So say you have $10,000 per month of net income and $3,500 of expenses leaves you with $6,500 mth to service a mortgage. We work out that an $800k mortgage over 30 years at a test rate of 8.95% will be $6,400 month so with $6,500 available and factoring a mortgage at $6,400 leaves $100 mth of Uncommitted Monthly Income ( UMI ) and in the process determined you can afford a mortgage up to $800k.

Loan to Value Ratio ( LVR ).
THEN it needs to meet LVR criteria being a measure of how much a bank can lend against a mortgaged property compared to the value of that property. So on a residential Owner Occupied ( OO ) property its set at 80% LVR, in other words you can lend up to 80% of the property value so say it’s a $1m home you can borrow up to $800k or 80% so therefore requiring a 20% or $200k deposit in that example.

Exceptions to the rule are –

• New builds you can have up to a 90% LVR

• First Home Buyers ( FHB ) can go up to 95% LVR with help from Kainga Ora

It then means however you also have to service the additional lending so given the above example with an $800k mortgage being the most you can afford under your UMI and you have a 95% LVR / 5% deposit then the max property value you can purchase will be an approx ( $800,000 / .95 ) $842,000 property … so would need $42k deposit being 5%. Either way on this example you could purchase a property with an $800k mortgage plus whatever deposit you had with the minimum being 5%.

First home buyer privileges are of course, the domain of first home buyers OR second change buyers being those that are in the same position as a first home buyer but you can’t own another property presently or recently.

Low Equity Lending ( LEL )
Anything under 80% LVR is considered low equity lending and special conditions apply.

The Reserve Bank has allowed banks an allocation or speed limit of 15% of their total lending to be written as high LVR / low deposit lending in a given period usually 3 – 6 months depending on bank size so to that end your own bank may be able to provide you with lending up to 90% LVR, this will be reserved for existing customers with no appetite for new to bank lending over 80% LVR.

Kainga Ora – Homes and Communities ( KO )
Outside of that, Kainga Ora was set up to assist First Home Buyers with low equity to step onto the property ladder. This essentially means you can apply with up to 95% LVR or 5% deposit with Kainga Ora essentially underwriting the balance to the bank of the amount over 80% LVR. Not all banks are part of this initiative with participating banks being Westpac, Kiwibank, Cooperative Bank, SBS Bank, Unity and NBS. UMI criteria still apply to determine the amount of funding available.

Click on the following link to Kainga Ora for more on that https://kaingaora.govt.nz/en_NZ/home-ownership/

Low Equity Premium ( LEP )
Lending over 80% LVR is considered high risk and will attract a Low Equity Premium( LEP ) either as a fee that can be capitalised ( added to the loan ) or as an added interest rate margin that can come off in time once the LVR increases over 80%. it varies between banks but generally it’s a fee based on the value of the loan scaled, for example if the LVR is between 80% - 85% will attract a 0.25% fee then from 85% - 90% a 0.75% fee and 90% - 95% a 1% fee. This helps banks mitigate the additional risk imposed through low equity lending. As an example a LEP fee of 0.25% charged where the LVR is between 80% - 85% will be $250 per $100,000 of lending.

Getting the deposit together
Deposits can come from a number of sources. If you’re not a FHB then own savings or equity from a sold property and if you are a FHB then it can come from any source which can include gifting from parents and a FHB grant of up to $5,000 for an existing property or $10,000 for a new build. Also you can use your Kiwisaver balance provided you’ve been in Kiwisaver for 3 years and you leave a min $1,000 in the account.

Not for FHB but you can also use equity on another existing property to put toward the mortgage on a new property with brings me to my next topic.

Investment property, rules for playing.

In the same way an Owner Occupied home has an LVR of 80% an investment property has an LVR of 65% or 35% deposit. This means you can borrow up to $650k on a $1m property or need $350k in equity or deposit. It also means if you currently own a $1m investment / rental property and want to pull some equity out to purchase an Owner Occupied property you’ll need to leave 65% in so finance up to $650k and if the current mortgage was $450k you could pull out $200k to use as deposit on an owner occupied property since you’ll need a max 80% LVR so provided you could service the payments on BOTH properties from your own and rental income then you could purchase another $1m property. This would produce a ‘weighted average’ LVR between the two properties of up to 72.5% with both typically cross securitised or some banks will allow separate securities. The same works the other way around if using equity on an owner occupied to buy an investment property

Low equity lending does not apply to investment property and we’ll delve a bit more into the investment property landscape once the brightline rules are eased and tax deductibility restored come July 1st.

The role of non-bank lenders
Non-bank lenders are typically privately funded or peer-to-peer lending. The restrictions imposed on main banks by the Reserve Bank in relation to LVR’s don’t apply however their own lending criteria and appetite for risk do. This means they can be a bit more liberal than main banks as they are less restricted however they typically run at a slightly higher interest rates to main banks. They will often step in where main banks can’t as a short term option with the idea to switch to main bank once their criteria are met in say a year or two.

Test rates
Banks also work on a ‘test rate’ so say you fix for 18 months at 6.69%, the ‘test rate’ the bank will use to determine affordability is run at 8.95% so if in the event when your fixed rate matures in 18 months and you go to refix and in the meantime some economic event has happened and interest rates have gone up, that you can afford the mortgage at the then new rate. It also means you have an element of play to work with between the test rate and what your actual rate is which allows a degree of comfort in your lending so you’re not stressed financially if something happens. The ‘test rate’ model was particularly useful post covid when loans were written at an all-time low of around 2.5% but applications were tested at 7.5% to ensure its affordable at the that rate which meant when the OCR was raised in response to rampant inflation and interest rates DID climb significantly that the mortgage was still affordable at the new rate … very wise indeed.

LVR’s set to ease and DTI’s to be phased in.
The Reserve Bank has been in discussions to ease the LVR restrictions and introduce Debt to Income ( DTI ) Ratios as a means of controlling personal debt levels. Basically it means you’ll be able to lend up to 6 times your gross income for investment and 7 times for owner occupied loans but more on that to come when its finally announced in about July.

So why all the UMI / LVR – LEP stuff and why all the restrictions?
In a nutshell, it’s all about responsible lending, ensuring you don’t get yourself into a position you can’t handle and it results in financial hardship for you, in essence protecting yourself from yourself. If there’s plenty of equity and affordability then there’s no problem but it starts to get a bit tricky when servicing is pushed to the max and equity is minimal, hence applying restrictions that only let it go so far.

To that end, the Reserve Bank ( RBNZ ) imposes restrictions on the main trading banks to ensure lending across the board is responsible and it also has an element of economic protection, for example if in an economic event occurred that lifted interest rates and caused a downturn in house prices then there’s a buffer to absorb some of the loss to retain equity with a sharp correction being a significant risk to the financial system. Housing, like other asset markets, can be subject to ‘fire sale’ effects in a downturn, where indebted borrowers sell property to pay down debt, which in turn depresses prices and creates further incentives to sell and/or reduce spending and borrowing.

The Official Cash Rate ( OCR ) … what it does and where it’s going.

The OCR is a tool the Reserve Bank ( RBNZ ) uses to dial the economy up of down depending on where it is and where we need it to be. It was effectively used post covid to stimulate the economy by winding down the OCR to 0.25%, the lowest its ever been with interest rates following with mortgage fixed rates as low as 2.5% meaning lots of cheap money around to spend in the economy. Then once it had its effect we found inflation took off due to high demand and major supply issues coupled with high net migration fuelling the cost of living crises so 16 months later the RBNZ started dialling it back up again incrementally 12 time in 20 months to finally rest at 5.5% in May 2023 where it sits right now and has been for exactly a year with floating mortgage rates up around 8.5%

So it’s been held there ever since while inflation and immigration settles down and its having its effect as we can all feel in our wallets hence the reason for cooling it off so it doesn’t get worse and now inflation is nearing the desired under 3.0% mark ( currently at 4% ) it’s not a matter of if but when the OCR starts to get dialled back.

The OCR committee meet and conduct a review about every 6 weeks with the next announcement due this Wed 22nd May. We’re not expecting any easing just yet and more like late this year to early next year but it does depend on the latest inflation figures. When it does start to turn it will be in small increments ideally resting around 2.5 – 3% finally by end of 2025 with interest rates a couple or three percent above that.

We’ll wait with baited breath and report back accordingly, it’ll be all over every media channel anyway.

Conclusion
UMI’s and LVR’s are here to stay in one form or another as well as DTI’s likely to be introduced. We really don’t want to be going through the crazy peaks and troughs we just have been in recent years so to that end it’s good to have them in place to maintain a steady economy and once we have inflation back under 3.0% and resting around 2.0 – 2.5% we’ll be in a better place with economic growth once again able to stretch its legs which will likely take to end of 2025 with all being well in the world so we have that to look forward to.