Get this right and avoid being declined!
Over the past few years, there have been significant changes to how banks calculate living expenses when assessing your overall borrowing power.
Generally speaking, banks have been casting a wider net on your expenses so to increase your chances of approval it’s important to be accurate in your home loan application.
How do banks calculate your expenses?
Believe it or not, lenders actually use the following three methods to calculate your living expenses. They will:
- Use the Household Expenditure Method (HEM)
- Ask you to self-assess your living expenses
- Review any bank account or credit card statements they have access to in order to confirm your self assessment
- Take the higher of these three methods to calculate your living expenses
Want to know how much you can borrow?
What is the Household Expenditure Method (HEM)?
The HEM is the benchmark that banks use for living expense allowances based on the size of your household, whether you’re a single applicant, a couple or you have dependents.
In addition to this, banks will cross-check this with whether you’re living in a metro area versus a non metro area for each state.
As you can imagine, it can get quite confusing and convoluted, particularly if you know you can cut non-essential living expenses such as gym memberships or eating takeaway.
For example, some lenders will consider the average living expenses for a couple earning $59,382 to $71,258 living in metro Queensland to be $2,317 per month.
This may jump to $2,496 per month when you add one dependent and $3017 when you add two.
In essence, it allows banks to determine how much they should reasonably lend to you so you can comfortably afford the mortgage repayments.
In doing so, they’re meeting their obligations under the National Consumer Credit Protection Act 2009 (NCCP Act).
So if you earn $200,000 per year, you’ll have higher allowable expenses than someone earning $50,000.
Give our living expenses calculator a try. It can give you can give you a pretty good idea as to where you stand compared to the HEM.
The use of the HEM method is relatively new, replacing the use of the Henderson Poverty Index (HPI) or Henderson Poverty Line in 2012.
How does a self assessment work?
For a while now, the Australian Securities and Investments Commission (ASIC) has required lenders to look far beyond the HEM when determining a borrower’s actual living expenses.
When completing a mortgage application, you’ll be required estimate regular ongoing expenses that fall outside the HEM completely.
These expenses include:
- Rent: Including board
- Clothing/personal care: Footwear, cosmetics, apparel, hygiene products and haircare etc.
- Education: Public, private and all associated costs including uniforms and textbooks.
- Groceries: Meat, fruit, vegetables, cleaning products, milk, bread and toiletries.
- Insurances: Health, home, home and contents, life, income, car, motorcycle and boat.
- Investment property: Utilities, rates, repairs and related costs including tax levies, body corporate and strata fees (for units).
- Transport: Public transport like buses, trains and taxis, petrol, registration, insurance, servicing and repairs..
- Connections: Phone (landline), Internet, mobile, subscription-based television and other subscriptions.
- Childcare: Childcare centre and preschool fees, nanny fees and after school home care etc.
- Medical health expenses: Doctors (GPs), dental, optometry, holistic medicine and specialists that fall outside of bulk billing or what’s covered by private health insurance.
- Recreation and entertainment: Take-out, pets, gifts, concerts, festivals, stage shows, opera, comedy etc.
- Owner occupied property: Utilities, rates and related costs including tax levies, body corporate and strata fees
- Other unique items: Only list if it’s a regular ongoing expense
How self assessment can go wrong
Inaccurate reporting of your living expenses can very easily overestimate or underestimate your borrowing power.
Mistakes are often made in the following ways:
- Rental expenses should be ignored if you’re buying a home but lenders sometimes lump in all expenses together and ignore this.
- If you forget to add in private school fees, you’ll be greenlit to borrow more than you can afford but this is ok if other expenses can be reduced in the event of hardship.
- If you’re buying a property, expenses such as council rates should be included but most estimate ‘future expenses’.
- Sometimes people include debts they pay in their living expenses but these should be recorded separately in your liabilities.
- People often grossly overestimate living expenses by including discretionary, one off spending such as a large overseas trip or a new car.
- Often people underestimate living expenses on purpose because they are aware that if their living expenses are too high then they may be declined.
You should have a discussion with your mortgage broker to make sure you correctly complete this section of the lender’s fact find.
How will the lender assess my accounts?
If you bank with them then it’s easy. They can see everything!
If you don’t bank then the bank may rely on any statements that you have provided and look for regular debits from your account that were not disclosed on your application.
Average spending is also taken into account.
Where this is really going to change is with positive credit reporting which allows for data sharing between the banks.
Are you self employed?
Often, lenders will see your business expenses and class them as personal expenses.
With the right evidence, you can argue the point with them so that your living expenses are being calculated accurately – a mortgage broker can help you do this.
What if I messed up and declared higher expenses than I actually pay?
Unfortunately, the lender may decline your home loan under the assumption that you can’t afford it.
They won’t tell you exactly which part of your living expenses put you over line.
Trying to argue the point with them is very hit and miss.
We’ve had some success with minor changes, cancelling expenses and providing a written letter explaining to the lender that these expenses are no longer regular and ongoing.
The alternative is to apply with another lender who takes a less stringent approach to calculating living expenses.
We know who these lenders are!
Ultimately, you are the only one who knows your living expenses.
If you’re in a position to cancel some unnecessary expenses or you simply made a mistake in your application, get in touch with us.
Call 1300 889 743 or fill in our online enquiry form today.
What if my partner isn’t on the loan?
Are you married or in a de facto relationship?
You need to include your wife or husband’s living expenses because lenders assume they are financially dependent on you.
However, if you can legitimately prove that your spouse isn’t financially dependent on you by providing payslips, some lenders can assess you as having ‘single’ living expenses.
This can make a huge difference to your borrowing power compared to detailing living expenses as a married couple.
What if I have debts with other people?
Joint debts with people not on the loan application are assessed by lenders as if the debts are 100% in your name.
They assume that the person isn’t paying their share – it’s totally insane!
Luckily, some lenders will assess you at 50% of the debt using what is known as a common debt reducer home loan.
Want to get approved the first time around?
The first step is providing accurate details living expenses.
By working with a mortgage broker, they can give a pretty accurate indication of your chances at approval.
Call us on 1300 889 743 or complete our free assessment form today.