Behind the curtain – how banks judge your living expenses

Household expenses list

It’s no secret that lenders have tightened up their criteria for approving loans. Everyone knows someone who has struggled to get a home loan these days, and it can seem like a huge hurdle to get approved. 

But once you know what raises a red flag for lenders it can be quite easy to make sure you are putting your best foot forward in your home loan application.

Here’s what you need to know before you hit that Apply Now button!

The Household Expenditure Measure

The way lenders evaluate living expenses is based on the Household Expenditure Measure (HEM) table. This table determines what the average household expenditure should be for each personal situation (single, couple, number of dependants, etc). 

It is an independent Australian measure that is used nationwide and across all lenders. It has been used for decades as the marker for how much it costs Australians to live day to day.

In the past lenders would look at your income minus the standard HEM figure for your circumstances and determine if you could afford the loan. Following this Banking Royal Commission, it is a little more complicated than that.

How HEM is used today

Banks must now first look at your monthly spending to see if it is within the HEM threshold for your situation. If your expenses are within the threshold, they evaluate your ability to pay the mortgage based on the suggested HEM amount for your circumstances. But if it is outside the level for HEM, they will then look in depth at your expenses to determine your ability to pay. 

This review is generally based on three months of spending and takes into consideration everything you spend money on.

Any contracted amounts or commitments such as private education payments are looked at, along with ongoing medical expenses or travel commitments. Recurring payments will be analysed, even if they are to charities or donations.

How to put your best foot forward

If you find yourself outside the HEM threshold, consider reducing your spending on expenses such as gambling and non-essential items such as Netflix or Foxtel. Consider pre-paying monthly items such as school fees or insurances, not to hide them but to try and get your monthly spending under the HEM threshold for the period being evaluated.

Any payments to third parties such as Afterpay or ZipPay might also be worth reducing, as these will also be considered as further credit obligations.

Ideally three months of controlled, budgeted spending will give you the best possible application and give the lender a good picture of your ability to service your new home loan.

The HEM threshold applies even if you have no existing debt or mortgages. You may be in the strongest financial position you have ever had, with significant savings and no debt and still get caught out by your living expenses. Banks assess using a buffer of an additional 2.5% on their current rate as their assessment interest rate, so they are looking at your capacity to pay a higher monthly mortgage payment than the one you are applying for today.

A good mortgage broker will have tools to enable them to quickly evaluate your current monthly spending and let you know if you should consider tightening your belt for a couple of months before applying for a loan. It is this kind of insight that can make all the difference when it comes time to submit that application.

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