HEM Living Expenses and How These Affect Loan Assessments
What are HEM living expenses and why are they important when you’re considering taking out a home loan? Will your living expenses have an impact on your borrowing power? Will lenders check your expenditures as part of your application? What are the minimum living expenses for home loan requirements set by lenders in the country?
If you’re thinking of buying a house, you should know that lenders have changed their assessment criteria in recent years. It’s also a process that is constantly evolving due to regulations for responsible lending. To help you improve your chances of securing that home loan, here are some important things to know when it comes to HEM.
Understanding the Household Expenditure Measure (HEM) and Its Effect on Home Loans
The Household Expenditure Measure (HEM) plays a crucial role in the assessment of home loans in Australia. It’s a benchmark used by lenders to determine the living expense allowances of borrowers based on various factors such as household size, income, and location. By analysing a borrower’s HEM living expenses, lenders can gauge their ability to comfortably repay the loan and assess their borrowing power.
These expenses vary depending on factors such as the city or region in which the borrower resides. For instance, the cost of housing in Brisbane is significantly higher than in rural areas. It is essential to consider these variations to accurately assess a borrower’s financial capacity.
These allowable expense amounts are based on Australian Bureau of Statistics data but can vary from lender to lender. This is why there can be variations in the calculation of your borrowing capacity from different lenders.
To help you understand further what impact this has on your home loan, here’s a list of factors lenders look into when using HEM to determine your eligibility for a loan.
- Basic necessities (food, clothing, transportation) – Living expenses encompass the fundamental requirements for sustenance, such as grocery bills, clothing expenditures, and transportation costs.
- Housing costs (rent or mortgage payments) – Housing costs, including rent or mortgage payments, are significant components of living expenses. Lenders consider the amount individuals or families spend on housing to ensure that it aligns with their income and financial capacity.
- Healthcare expenses – Calculations for HEM living expenses also take into account healthcare expenses. These include visits to doctors or specialists, medication costs, dental care, and optometry.
- Utilities and bills – Utilities, such as electricity, water, gas, and internet services, as well as regular bills like phone bills, are included in the calculation of living expenses.
- Education and childcare costs – For individuals or families with children, education and childcare costs are crucial considerations. This includes school fees, uniforms, textbooks, childcare centre fees, and after-school care costs.
- Insurance and other financial obligations – HEM calculations also take into account insurance premiums, such as health insurance, home and contents insurance, life insurance, and car insurance. Additionally, other financial obligations include personal loans, credit card repayments, and ongoing debts.
Household Expenditure Measure (HEM) Example
To help you further understand HEM and how it’s calculated, let’s use this example to compute for HEM. Using a standard HEM calculator, we’ve come up with two examples – one for a childless couple and another for a couple with two kids:
Couple without kids
Annual earnings: $85,000
Less TAX at say 22% = Net $66,300 pa
HEM $34,896 – Minimum HEM figure that excludes mortgage or rent payments
Also does not take into account any additional costs like Personal Health Insurance and Private school fees which are on top of basic HEM as above.
Leaves approx $31,404 pa available for Mortgage Payments and all other debts to be serviced (at banks assessment rates).
Couple with 2 kids
Annual earnings: $85,000
Less TAX at say 22% = Net $66,300 pa
HEM $42,888 – Minimum HEM figure that excludes mortgage or rent payments
Also does not take into account any additional costs like Personal Health Insurance and Private school fees which are on top of basic HEM as above.
Leaves approx $23,412 pa available for Mortgage Payments and all other debts to be serviced (at banks assessment rates).
As you can see, the HEM for a couple with two kids is higher than the HEM for a couple without kids. This is because the couple with children has additional expenses for things like childcare, clothing, and education and extra food etc.
It’s important to note that these are just examples and the actual HEM for a household will vary depending on a number of factors, such as the location of the household, the income coming into the household, the size of the household, and the household’s spending habits.
Determining Your Borrowing Capacity and a Lender’s Assessment of Living Expenses
Determining your borrowing capacity is a crucial step in the process of securing a home loan. Lenders carefully assess various factors to determine how much they can comfortably lend you based on your financial circumstances. Here are some of the things they do to figure out your borrowing capacity:
The role of HEM in determining living expense allowances
In the process of evaluating loan applications, lenders rely on various methods to assess a borrower’s living expenses. One such method is the Household Expenditure Measure (HEM).
It provides a standardised framework for calculating living expenses, taking into account basic necessities and essential costs associated with maintaining a reasonable standard of living. By using the HEM, lenders can establish a baseline for assessing a borrower’s ability to manage his or her finances while meeting loan repayment obligations.
Self-assessment and reporting of living expenses
Borrowers are typically required to provide a self-assessment of their living expenses as part of the loan application process. This involves reporting detailed information about various expenditure categories, including food, housing, transport, healthcare, education, and other regular expenses.
Lenders use this information as a starting point to evaluate the borrower’s financial capability. Note that it is crucial for borrowers to provide accurate and honest self-assessments to ensure a fair evaluation of their living expenses.
Examination of bank account statements and credit card history
To gain a comprehensive understanding of a borrower’s financial situation, lenders often review their bank account statements and credit card history. This scrutiny allows lenders to verify the accuracy of the borrower’s self-reported living expenses.
By analysing these financial records, lenders can check the consistency between reported expenses and actual spending patterns. Any discrepancies or irregularities in the borrower’s financial behaviour may be taken into consideration during the loan assessment process.
Adjustments made by lenders based on actual spending patterns
In some cases, lenders may make adjustments to the borrower’s reported living expenses based on their analysis of bank account statements and credit card history. If discrepancies or inconsistencies are found, lenders may modify the borrower’s stated expenses to align them with their actual spending patterns.
This adjustment aims to provide a more realistic assessment of the borrower’s financial situation and ensure that the loan amount offered is within the borrower’s means. Lenders also take into account the higher of the self-assessed living expenses or the adjusted expenses based on the examination of financial records.
By conducting a thorough assessment of living expenses, lenders can accurately evaluate a borrower’s ability to manage his or her finances and meet loan repayment obligations. It’s essential for borrowers to provide truthful and transparent information regarding their living expenses to ensure a fair evaluation and increase their chances of securing a suitable home loan.
HEM Levels and Variations
The HEM plays a significant role in determining living expense allowances for loan assessments. Understanding the different levels of HEM is crucial for borrowers as it directly impacts their borrowing capacity and loan eligibility.
Typically, larger households with more dependents tend to have higher HEM levels to account for increased expenses. Similarly, households with higher incomes may have higher HEM levels as their spending patterns and lifestyle may reflect a higher standard of living.
HEM Levels: Basic, Moderate, and Lavish
HEM levels are used by lenders to determine living expense allowances when assessing loan applications. These levels categorise living expenses into three distinct categories: basic, moderate, and lavish. The categorisation is based on the average expenditure patterns of households with similar characteristics.
Basic HEM Level – This level represents essential living expenses required to maintain a basic standard of living. It includes necessities such as food, clothing, transport, housing costs (rent or mortgage payments), healthcare expenses, utilities, and bills. Basic HEM levels are designed to reflect a conservative and frugal lifestyle.
Moderate HEM Level – The moderate HEM level represents a slightly higher standard of living compared to the basic level. It includes additional discretionary expenses, such as dining out, entertainment, and some savings. Moderate HEM levels cater to individuals or households who desire a more comfortable lifestyle while still maintaining responsible financial practices.
Lavish HEM Level: The lavish HEM level reflects a higher standard of living with more discretionary spending. It includes luxury expenses, such as extravagant vacations, high-end dining, and indulgent hobbies. This level is typically for individuals or households with higher incomes and a desire for a more luxurious lifestyle.
The categorisation of HEM levels allows lenders with the help of an HEM living expenses calculator to assess a borrower’s living expenses within the context of their desired lifestyle and financial capacity. It’s important for borrowers to be aware of these levels as they directly impact the borrowing capacity and loan eligibility.
A Word of Caution on Self-Assessment
Incorrectly reporting your HEM living expenses can affect your borrowing power due to overestimating or underestimating your expenses.
Avoid these common mistakes to improve your approval chances:
- Debts should be recorded separately under liabilities, not as regular, ongoing living expenses.
- Don’t underestimate your living expenses to affect borrowing power. Lenders have access to your bank statements as part of your application and can cross-check your spending habits.
- Don’t add discretionary, one-off spending, like purchasing a car or a holiday trip – this will cause an overestimation.
- Ensure that ongoing expenses, like your children’s private school fees, are included in your living expenses so your lender has accurate information.
- Rental expenses should be excluded by lenders. They should only calculate living expenses that will continue once you have a mortgage.
- Discuss any concerns with an experienced mortgage broker to make sure your home loan application is a complete and accurate self-assessment.
How Lenders Review Banks Accounts and Account Statements
If you bank with the lender, then their review will be an easy one with full access to your accounts, however, if you bank elsewhere you may need to provide statements for certain periods. The lender will look for regular debits from your account(s) that were not disclosed in your application.
A word of warning: If you are self-employed, lenders will often see your business expenses and include them as personal expenses. An experienced mortgage broker can assist you with having the right evidence to ensure your living expenses are accurately represented.
What else do I need to know to get the best chance of approval on my Brisbane home loan application and how can NBHL help?
1. Accidentally declaring you spend more can mean a declined home loan
If you get a declined application and you suspect you have declared too much spending, we can liaise with the lender on your behalf with evidence that expenses are no longer ongoing. Or, we can help you apply to a different lender who we know will be less stringent in their approach to living expense calculations.
2. If you’re married or in a de facto relationship, this can still affect borrowing power, even if your partner is not on the loan
Lenders will assume your spouse is financially dependent on you so you will need to include their living expenses on your application. If not, we may be able to help you prove your spouse isn’t financially dependent on you so you can be assessed as having “single” living expenses.
3. Debts with other people could be assessed as 100% in your name
Joint debts with people not on the loan application can be classified by some lenders as yours alone. However, there are some lenders available to you who will assess you at 50%, known as a common debt reducer home loan. We can help you locate these lenders.
If all this information has left you a little confused about how a mortgage lender will assess your living expenses and the effect of HEM living expenses on your home loan, don’t worry. It is rather confusing due to all the information you need to digest. There are also a few other variables between different lenders that can mean more headaches for applicants.
You can grasp all these mind-boggling details by trusting a mortgage broker who can walk you through the basics. Understanding what you need to do when it comes to calculating your home loan living expenses requirement isn’t easy. Talk to us today, and we can ensure you get the best chance at approval for your home loan the first time.
Let the Brisbane mortgage brokers at NBHL help
We hope this information has been helpful. If you have any questions, our North Brisbane mortgage brokers are here to help. They will be able to provide you with a more accurate assessment of your living expenses and give you the best chance of approval on your mortgage application.
Contact us today to get started!
Patrick Cranshaw, a Certified Mortgage Professional for over 21 years, founded North Brisbane Home Loans in 2002. His career began with ANZ Bank in New Zealand, where he progressed over 16 years to a Business Banking role in Virginia. After moving to Brisbane in 2000, Patrick led the QLD market for a home loan agency, helped set up the REMAX Real Estate Finance division, and practiced as a broker.
