For anyone that had been through the home loan process in the past, it is unlikely you were ever asked about your monthly living expenses, outside current financial commitments such as loans, credit cards etc This is because up until recently, mortgage lenders all used an assigned minimum monthly living expense amount, based on statistical data compiled by companies like Moody's or Standard & Poor's. These companies compiled data on the 'average' cost of living for different applicant types such as a single person, a couple with no kids and families of almost any size.
However, in 2016 the Australian Prudential Regulator (APRA) started working with lenders to have each applicant(s) self-declare their own living expenses. This was based on the fact that people with the same family status don't all spend the exact same amount on their day to day lives.
In the early stages of this new concept, it was what we'd call a 'soft roll out'. Clients were asked to declare a figure for their monthly living expenses, but little to no verification of the accuracy of the figures was really completed. However, things have started to ramp up and the banks are now really cracking down on the figures declared and how these figures compare to a new reference point, known as HEM (Household Expenditure Measure).
HEM differs from the old figures that the banks used in that they vary based on where people live, and increases as an applicant's taxable income rises. For example, prior to the use of HEM, the minimum monthly living expenses used to assess a single person living in a rural town earning $50,000 per annum was the same as say, a young lawyer, working in Sydney earning $165,000. The HEM is also updated more regularly and adjusted for inflation.
How does this affect you?
If you are planning on applying for a home loan now, or in the future, you will be asked to declare your household living expenses in up to thirteen categories. These are
Rates & Utility expenses for your own home
Rates & Utility expenses for your investment property/s (if applicable)
Pay Television expenses (if applicable)
Recreation & Entertainment
Clothing & Personal Care
Medical & Health Costs (excluding Health insurance premiums)
Education (if applicable)
Childcare (if applicable)
Other expenses not associated in any of the above categories
Once you have provided your figures for all the applicable categories, the bank will use the higher of the two if you declare a total figure that is below the assigned HEM value for you.
However, we are currently experiencing a number of issues with certain lenders when applicants declare their monthly living expenses are a noticeably lower figure than the assigned HEM figure. Where the lender feels the declared figure is 'too low' they are requesting further investigation into the figures and in some cases are going through clients bank statements, line by line, to compare each and every expense against the declared values. This is becoming time-consuming and in many cases means loan amounts are reduced, or the loan applied for cannot even be proceeded with.
Of course, if you declare your expenses at a higher figure than your assigned HEM value, this reduces your uncommitted monthly income, reducing your total borrowing power.
The current process is not without a number of issues though but like many large changes in a long-term process, issues arise and are smoothed out as time goes on. The parts of this that we'd personally like to see handled a little differently are the way in which discretionary spending is looked at. For example, a newlywed couple may spend more than usual in the year or two leading up to their wedding but once married and living together it is expected that total living expenses for the couple would fall.
Also, where an applicant genuinely spends less than their assigned HEM and can even prove it, the bank will still use the higher of the two figures!
What are the benefits?
While clients and brokers alike currently deal with this new requirement, that for the time being, adds complexity, time and some frustration to the loan application process, the long-term benefits are that customers are made aware of their true living expenses and borrow appropriately. In many cases, we are seeing clients genuinely learn that they are spending more than they thought, which can lead to positive changes in their spending habits in the medium to long-term.