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When you apply for a home loan in Australia, one key factor that can significantly affect your application is your living expenses, which are assessed using the Household Expenditure Measure (HEM).
As the cost of living continues to rise, banks are closely examining how much you spend before approving your loan.
In this guide, we’ll explain how the HEM works and offer practical tips to help you improve your chances of securing a home loan.
Key Highlights
Household Expenditure Measure (HEM): A tool used by Australian banks to estimate your minimum living expenses when assessing home loan applications.
Expense Categories: HEM splits expenses into essentials like food and utilities, and discretionary spending like entertainment, typically capped at 25%.
Impact on Borrowing Power: Your income, living expenses, and debts determine how much you can borrow. Even small expense changes can boost your borrowing capacity.
Factors Influencing HEM: Household size, income level, and location affect your HEM, which banks adjust based on your financial situation.
Improve Your Borrowing Power: Review your spending, cut discretionary costs, use budgeting tools, and make sustainable financial changes.
Role of Mortgage Brokers: Brokers help you navigate HEM, ensure accurate expense reporting, and improve your loan application.
What Is the Household Expenditure Measure (HEM)?
The Household Expenditure Measure (HEM) is a tool used by banks in Australia. It helps banks find out the minimum living expenses a borrower needs. This is based on their household size, income, and where they live. HEM was made by the Melbourne Institute of Applied Economics. It helps lenders make sure that people do not borrow more money than they can handle.
Components of HEM
The Household Expenditure Measure breaks your expenses into two main categories:
Basic essentials
These are the important costs we need for daily life. They include things like food, bills, travel, and self-care.
Discretionary spending:
This is about costs that are not necessary. These costs can be for eating out, fun activities, and hobbies. Usually, we spend around 25% of our total expenses on discretionary items under HEM.
HEM does not cover some important costs. This includes rent, mortgage repayments, private school fees, and gambling losses. Banks look at these costs separately when they check a loan application.
How Does HEM Impact Your Borrowing Capacity?
When you apply for a home loan, banks check your living expenses using HEM. They want to see how much you can borrow. Here is how it works:
Income: Start with how much money you make, like your salary or wages. – Example: $100,000 each year.
Subtract tax: The bank will take away the tax amount you pay. – Example: After paying $23,000 in tax, you have $77,000 left.
Subtract living expenses: These costs include rent, groceries, utilities, and more. – Example: If your living expenses are $33,000, you now have $44,000.
Account for other debts: If you have debts like credit card payments or a car loan, the bank will subtract these amounts. – Example: After paying $7,000 for your car loan, you have $37,000 left for a mortgage.
The leftover amount ($37,000 in this case) is what the bank looks at to figure out how much you can borrow. A little cut in your living expenses can greatly boost your borrowing power.
Why Accurate Living Expenses Are Critical
Banks do not only use the HEM. They also look at what you say your living expenses are. When you ask for a loan, you need to give them details about how you spend your money. This includes categories like food, utilities, and transport. The bank will check your stated expenses against the HEM benchmark and your actual bank statements. If they find big differences, they may change your figures or refuse your loan.
If you say you spend $500 a month on groceries for your family but your bank statements show you really spend about $1,200, the bank may change its estimates. They might raise your reported expenses. As a result, this could lower your borrowing capacity.
HEM Calculation: What Affects Your HEM Benchmark?
HEM is not a set amount. It changes based on your personal situation. Banks look at several factors, including:
Household size: Bigger households usually spend more on living expenses, which raises their HEM benchmark. – Example: A family of four will spend more than a single person or a couple without kids.
Income level: Households with higher income tend to have higher living expenses, which banks consider in their HEM calculation. – Example: A person making $120,000 a year will have a higher HEM than someone making $60,000.
Geographic location: Living costs change depending on where you live. For example, living in Sydney or Melbourne means higher living expenses than in rural or cheaper areas.
Other factors: Lifestyle choices, like traveling a lot, having hobbies, or eating out, can affect how banks judge your living expenses. However, these choices are usually optional and limited by HEM.
Real-World Example: How HEM Affects Borrowing Power
Let’s compare two families living in Sydney:
Family 1: A couple with two kids earns $90,000 after taxes. Their household expenses are about $60,000. They have $30,000 left for mortgage payments.
Family 2: A couple without kids, who also earn $90,000, has household expenses around $51,000. They have almost $9,000 more for mortgage payments. This increases their borrowing capacity by up to $100,000.
This example shows how the size of your family and your living expenses can affect how much you can borrow.
Tips to Improve Your Borrowing Capacity
1. Review and Categorise Your Spending
Start by looking closely at what you spent over the last 3 to 6 months. Sort your costs into groups like food, transport, utilities, and entertainment. This will help you see where your money is going. Consider using a system like the Barefoot Investor bank accounts.
2. Cut Back on Discretionary Spending
Look for ways to cut down on unneeded spending. For example, eating out less, canceling subscriptions you don’t use, or spending less on entertainment can help your money situation.
3. Make Sustainable Changes
Any cuts in spending should be long-lasting. Banks will check your spending for several months, so any changes need to stick for the long haul.
4. Use Budgeting Tools
There are many apps and online tools that can help you keep track of your spending. These tools can help you find places to save money and meet HEM expectations better.
5. Plan for Life Changes
If you are looking for big changes like starting a family or changing jobs, include these in your budget plan. Banks will think about how these changes could affect your chances of paying back a loan.
Real-World Case: What Happens If You Get It Wrong
Sarah is a client at Hunter Galloway. She said she spent $500 a month on food for her family of four. But her bank statements showed her spending was more like $1,200. This a few caused some concern for the lender. They changed her living expenses, which lowered her borrowing capacity. In the end, her loan was not approved.
Had Sarah spoken to a mortgage broker before, she could have changed her spending or made sure that her reported expenses were right.
Legal Considerations: The ‘Wagyu and Shiraz’ Case
In 2019, the well-known “Wagyu and Shiraz” case changed how banks look at living expenses. The Australian Securities and Investments Commission (ASIC) sued Westpac. They claimed the bank depended too much on the Household Expenditure Method (HEM) instead of considering real expenses when giving out loans.
The judge decided that Westpac was right. He said that people can change their spending to afford their mortgage repayments. This decision allows banks to be more flexible when looking at living expenses. However, it also means that borrowers need to explain their expenses better.
Common Myths About HEM
Let’s debunk a few misconceptions about HEM:
Myth: HEM is the only thing banks think about when looking at expenses.
Reality: Banks do use HEM as a guide. They also check your self-reported expenses and your bank statements.
Myth: Cutting expenses right before applying for a loan will help your chances.
Reality: Banks check 3-6 months of spending history. So, last-minute changes might not help much.
Myth: HEM is the same for everyone.
Reality: HEM changes based on things like household size, income, and where you live.
How Mortgage Brokers Can Help You Navigate HEM
Working with a mortgage broker can really help you understand the complicated parts of HEM.
Expertise: Brokers know the HEM policies of different lenders. They can help you adjust your loan application to meet those standards.
Guidance: A broker can give you tips on how to boost your borrowing capacity by managing your spending wisely.
Accuracy: They can check that your listed expenses are correct and realistic. This helps prevent any problems with the bank.
Conclusion: Mastering HEM for Home Loan Success
Understanding the Household Expenditure Measure (HEM) is very important when you apply for a home loan. When you report your living expenses accurately and change your spending habits for the better, you can greatly boost your chances of getting approved for a loan. Keep in mind that even though HEM is important, banks will also check your real spending patterns.
At Hunter Galloway, we help clients improve their finances and support them when applying for a home loan. If you are getting ready to apply for a loan, reach out to us for a free consultation. We will help you understand your borrowing capacity. With the right plan, you will be on track to reach your property goals.
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