The Reserve Bank will have the go-ahead to begin developing rules limiting lending to income levels although first home buyers may be largely exempt.
On Tuesday Finance Minister Grant Robertson announced he had reached an agreement with Reserve Bank governor Adrian Orr to amend their agreement on macro prudential tools.
Central to this is a new debt serviceability tool, which could limit borrowers to a certain multiple of their income.
"I have largely agreed to the Treasury and Reserve Bank's proposed update to the [memorandum of understanding] to add debt serviceability tools, but as I indicated in June this extension should not unduly impact first home buyers," Robertson said in a statement.
An amendment to the agreement states that in "designing and implementing a debt serviceability restriction, the Reserve Bank will need to have regard to avoiding negative impacts, as much as possible, on first home buyers," according to Robertson's office.
"I believe this agreed wording will set clear public expectations while maintaining the operational independence of the Reserve Bank," Robertson said.
"It is still up to the Reserve Bank how it chooses to introduce any restrictions, having had regard to this condition."
The Reserve Bank plans to reintroduce loan-to-value ratio (LVR) restrictions from October and is also expected to begin consulting on debt to income (DTI) restrictions or interest rate floors. Consultation on the possible changes would take at least three months.
"The Government has already put in place a number of measures to cool the housing market to make house prices more sustainable and tilt the balance in favour of first home buyers, including extending the bright-line test and removal of interest deductibility," Robertson said.
"These initiatives will make a real difference. However, there is no silver bullet to housing affordability and monetary and fiscal policy need to work together to achieve a sustainable housing market," Robertson said.
Earlier this year both the Reserve Bank and the Treasury predicted that house price inflation would drop almost immediately to zero before returning to low single digit growth.
Eventually the Treasury was forced to admit its prediction was based more on "judgement" than economic modelling.