Are you looking to apply for a home loan this year, and you’re receiving rental income or you’ll have rental income after the application? For example, you plan to borrow for purchasing or building an investment property, or upgrade your family home and convert your old family home into an investment property, or any plan related with the purpose of property investment in New Zealand.

If your answer is yes, we highly recommend applying for a home loan as soon as possible. If you keep waiting, then potentially your borrowing capacity may be reduced dramatically.

In this video, we’ll explain the why and share our view on how banks may change their lending polices to cope with the newly released housing rules regarding the removal of interest deductions on residential investment property. What’s more, we’ll use an example to quantify how your borrowing power may be reduced once the new policies become effective, so that you can understand the urgency of applying for a home loan before it’s too late.

Mortgage interest deductions on residential rental property

Video Timeline:

1. Recap on new housing rules: the removal of interest deductions on residential investment property - 00:41

2. How the policy changes may reduce your borrowing power? - 02:29

1. Recap on new housing rules: the removal of interest deductions on residential investment property

You probably have heard that a new housing policy was announced by the New Zealand government in March 2021. Inside of the package, the extension of the bright-line test was widely anticipated but removing interest deductions on residential investment property caught investors by surprise.

If you acquire a residential investment property on or after 27 March 2021, the interest expenses will not be able to offset against the rental income starting from 1 October 2021. For the property acquired before 27 March 2021, the interests on the home loan will become progressively non-tax deductible against rental income effective from 1 October 2021.

In our view, the change to tax deductions on investment property hurts highly leveraged investors the most – not all the interest expenses will not be included in the expense item, resulting in paying more tax and reducing cash flow eventually.

To cope with the Government’s new housing rules, lenders are reviewing their lending policies as they know you will have less cash to service a loan. Although they haven’t announced any policy changes yet because any significant change often takes some time to review and test before they can be released, one thing for sure – the lending policy change rolls in on the wheels of inevitability, and it is just a matter of time.

2. How the policy changes may reduce your borrowing power?

We don’t know yet when and how lenders will change their lending policies. Still, to give you a rough idea of how the removal of interest deductions on a rental property can affect your borrowing power in practice, we’re going to help you quantify the impact. Let’s dive in:

As the average loan size for our existing clients is around $750,000, let’s assume that you also plan to borrow for $750,000 against a rental property. If this is the case, the interest cost per annum is approx.$17,000 ($750,000 x 2.29% current interest rate). If this amount of interest cost cannot be claimed as expense going forward, you’ll need to pay extra tax of $5700 ($17,000 x 33% assume this is your tax rate)

In other words, it means you have $5,700 less cash to service the new loan repayment. From our experience, your borrowing capacity could be reduced by roughly in a range between $60,000 to $70,000. Again, this number is only based on a hypothetical case as we have no clue how the lending policy in terms of servicing ability is going to be changed.

We anticipate that banks may be also considering adopting other measures to tighten up their lending policies, such as using a higher test rate for assessing investment property loans, or discounting more when calculating your rental income.

That’s why we’d recommend you acting now if you plan to borrow money to do one of the followings this year:

• you’re looking to upgrade home, and turn your existing family home into a rental property
• you plan to purchase a rental property – despite that the new housing policy is spooking many people, property investment is still one of the most popular choices for the long term.
• you have a plan to build some new houses on existing land you own. Considering the new builds are exempt from bright-line rule and potentially exempt from interest deductibility rule, more and more people will be incentivised to build new houses, if they have a big piece of land.

If you fall into any of the categories above, you certainly should start applying for a home loan before banks’ movements. Don’t wait for another few months because it may happen very soon, and you won’t be able to borrow as much as you can at the moment.

Prosperity Finance - Here to Help

Want to know more about how the changes affect you? Or looking to apply for a new home loan? Call us at 09 930 8999 to have a no-obligation chat with one of the financial advisors at Prosperity Finance for a further discussion on your situation. 

Read more:

ANZ tightens servicing for rental property income, will this affect you?

New housing policy 2021: Can investors still afford to hold the properties they have?

Restructure your loan before it’s too late

Disclaimer: The content in this article are provided for general situation purpose only. To the extent that any such information, opinions, views and recommendations constitute advice, they do not take into account any person’s particular financial situation or goals and, accordingly, do not constitute personalised financial advice. We therefore recommend that you seek advice from your adviser before taking any action.