6 min read | 1 Jun 2020
No matter who you are, if you're applying for a mortgage, lenders will go through your living expenses with a fine-toothed comb, to confirm that you can afford your repayments if approved.
While it can feel a bit invasive to have someone go through all of your expenses in detail, remember it is all part of responsible lending practises, and ultimately to your benefit.
Before the GFC and then the Royal Commission, we heard many horror stories from borrowers that they were approved for way more than they could afford to repay, leaving them in serious financial trouble- in many cases having the bank foreclose on their home. Eek.
While lenders have always had to demonstrate responsible lending, they have certainly become more vigilant recently.
Credit licensees (lenders) must comply with the responsible lending conduct obligations of the National Consumer Credit Protection Act 2009 (National Credit Act).
Effectively it says they must not enter into a credit contract or consumer lease with a consumer, suggest a credit contract or consumer lease to a consumer or assist a consumer to apply for a credit contract or consumer lease if the credit contract or consumer lease is unsuitable for the consumer.
Make reasonable enquiries about the consumer’s financial situation, and their requirements and objectives;
Take reasonable steps to verify the consumer’s financial situation; and
Make a preliminary assessment (if providing credit assistance) or final assessment (if they are the credit provider or lessor) about whether the credit contract or consumer lease is ‘not unsuitable’ for the consumer (based on the inquiries and information obtained in the first two steps).
In plain English, this means that lenders (or brokers) will assess many financial factors about you when deciding how much they are willing to lend you.
They will look at your income and, unless you are self-employed, will look at payslips or your bank statements, for up to six months to confirm you earn a steady and regular income. In the case of self-employed people, they will look at your tax returns for two years and may require a letter from your accountant to verify your income. But that’s a whole other topic.
Lenders will also look at any loans and credit cards you already have because those repayments equate to money that could be going towards your mortgage.
They will also ask whether you are a single or joint income family and whether you have any dependent children (and a dependent spouse in the case of single income families).
The HEM method is the more prominent of the two methods used and is calculated on the median spend on absolute basics in life. It also calculates the average spend (the 25th percentile average spend to be specific) on discretionary basics. These are non-essential basic things like alcohol, eating out and entertainment and childcare (although some may argue childcare is essential for additional income and parental sanity). Some lenders don’t factor in this type of spending, such as overseas holidays, which are not regular monthly expenses, but others do, so it pays to check what your preferred lender does.
The HPI is the less common measure and was based on a survey of 1950s New York families, but has since been adapted for Australia, and calculates based on a family of two adults and two kids. There is a sophisticated algorithm using fractions to calculate different family structures. However, it is not so commonly used anymore, with HEM being the primary measure.
Food and Groceries - This is what you might buy in your weekly shop such as fruit, veg, household items and also takeaway food, if you regularly by coffees and lunches, this is spot to include these items
Housing and Property expenses – This doesn’t include mortgage repayments, but does include water, gas/electricity, council rates, strata fees, land tax, agent fees, maintenance, cleaning and investment property expenses.
Communication – internet, mobile phone and landlines, pay TV and media streaming subscriptions and internet.
Education – School and uni fees, uniforms, books.
Clothing and Personal care – hair and beauty treatments., clothes, shoes and beauty products
Transport and auto – car rego or public transport, petrol, tolls, car repairs and maintenance.
Medical, Health and Fitness – doctors and dentists, prescriptions, vitamins, glasses, physiotherapy, gym membership.
Insurance – Car, home and contents, Landlord insurance, private health, income protection, life insurance
Recreation and travel – sports, leisure activities, holidays, restaurants and concerts, movies, cigarettes and alcohol, gambling
Children and Pets – childcare, kids sports, music lessons, tuition and pet expenses
Other expenses – anything else not covered in the ten prior comprehensive categories.
Pretty intense right? If there’s stuff you can do without in the months leading up to applying for a home loan, it is an excellent idea to minimise that spending. Selling the children is not an option by the way.
Do you really need Foxtel, Netflix, Stan and Acorn? Maybe just one will suffice.
Perhaps you can cut down on your restaurant meals, or quit smoking?
Lenders may also look at your bank statements, and these days it can take a little longer to get approval with “tap and go”, and AfterPay transactions making statements look a bit messier. Our tip is to avoid AfterPay if you can, as it is another line of credit that will show up as debt. And if you use tap and go regularly, try and use cash for small purchases instead, so your statements look neater and easier to follow.
Lenders then look at your actual outgoings and compare them to the HEM or HPI calculation for someone who lives in your area with the same number of dependents. The lender then uses the higher figure from either your declared expenses or the HEM or HPI figure relevant to your situation, which they use to decide if they will give you a mortgage and for how much.
The other important thing to note is that you have a right to a written copy of your preliminary or final assessment if you ask for it.
If you are planning to apply for a mortgage and have time up your sleeve, look at what you are spending and whether there are things you could cut back on to free up some income. There are lots of calculators that can help give you a ballpark amount of what lenders may be willing to lend you before you take the big step of applying.
Be sure to marry that up against interest rates on offer too. If you have a regular PAYG income, check out what Athena has to offer, because we have one of the lowest interest rates around for both owner occupiers and investors.