One of the big contributing factors in how much a bank will lend you to buy a home, is living expenses. Your broker (and lender) needs to know what you spend each week on groceries, takeaway, coffee, gym memberships and phone bills, for example, so they can subtract that from your earnings and work out how much you can safely afford to pay back.
In 2017, UBS estimated 80% of all Australian home loans were approved using the Household Expenditure Measure, or “HEMs” as most brokers refer to it, which uses data from the Australian Bureau of Statistics and calculates a figure based on whether you’re single, a couple or a family applying for the loan, your location and the amount you spend on living expenses.
The HEM method
The royal commission into the banking sector questioned the use of HEM and found that for many people it isn’t an accurate reading of most people’s living expenses and actually seriously falls short.
“While the HEM can have some utility when assessing serviceability (of a loan) — that is to say, in assessing whether a particular consumer is likely to experience substantial hardship as a result of meeting their obligation to repay a line of credit — the measure should not and cannot be used as a substitute for inquiries or verification,” the commission report stated.
Since then the corporate regulator, ASIC, has followed up with legal action and provided updated guidance to brokers and lenders on how to use HEM. For example for first home buyers it can be useful to provide an estimate of expenses, as expenses significantly change in making the move to homeownership. However HEM does not include some types of expenses such as health insurance, overseas travel or private school fees. So HEM is not currently a complete solution and your total expenditure will need to be considered by your broker to work out your living expenses.
Photo by Thibault Penin on Unsplash ### Watch (out for) Netflix
While some home buyers are savvy about paying off credit card debt and car loans prior to applying for a home loan, others are failing to disclose how much they actually spend each week on things like Uber Eats, Netflix and Afterpay purchases.
Certainly, when we asked one of our brokers, Kym, about this very topic, she had a lot to say.
“I’m feeling frustrated,” Kym said. “I have three loans sitting on my desk and none of them can go ahead because of their living expenses. Some have no idea of the impact that their spending has on their ability to get a loan and some think that they will just cut back once they take on the debt. The message is just not getting through!”
Some of the problem lies in the fact that when many home buyers hear the term living expenses they think of things like internet, phone bills, weekly groceries and maybe their gym membership. They forget that living expenses also refers to subscriptions to Stan and Amazon, to wine and cigarettes and pizza, to bulk family purchases like nappies and formula, to daycare and visits to the vet, weekend ferry rides, trips to the dentist and new glasses.
Photo by Anh Nguyen on Unsplash### Do you really need to buy a salad… every day?
Kym says in order for home buyers to show they can afford a loan, the key things they should do are:
- Cut back on discretionary spending: “This means things like takeaway – yes that Friday night Thai meal, yes that McDonalds drive through on the weekend and yes that salad you buy every day for lunch.”
- Stop spending so much online: “Sometimes I don’t think people realise how much they spend on clothes, toys and books online. Just because it’s not in your hand immediately, you still bought it!”
- Entertain at home more: “Sure a night out at the movies or a nice restaurant once in a while isn’t going to break the bank, but if you’re doing it three times a week then you need to cut back. Try watching TV at home and cooking a nice meal instead.”
- Be aware just how much you’re spending on small items like coffee, wine and cigarettes: “$4 a day on a coffee or $15 a week on a bottle of wine may not seem like much, but it does add up. If you can forgo the bought coffee, you’ll save yourself almost $1,500 a year.”
While there is no hard and fast rule about how much people should be limiting their living expenses to, Kym says that past spending habits that show up in your transaction history will be taken into account by lenders as well as the HEM benchmark.
“Lenders are looking for signs that you can service a loan and any additional expense counts towards what you can and can’t borrow,” she says.
“A couple of tips my parents drilled into me from a young age, which I’m grateful that I (eventually) listened to are:
- ‘Cash is king‘… so basically, if you can’t afford to pay your credit card off each month, then you can’t afford it (yes, I know it’s harder than it sounds, but it just takes good discipline);
- and always aim to save a minimum of 30% of your pay, irrespective of what you earn.”
Here is UNO’s checklist of items that fall into the “living expenses” category. You can use your bank transactions and credit card statements as a guide to work out how much you’re spending each week / month.
ASIC also provide a budget planner that you can use for free through their MoneySmart website. This allows you to go through all your expenses in detail and work out where your money is going.
And remember, if you have any questions or need some advice about any of this stuff, the team at UNO is here to help.