How are my Living Expenses calculated in 2018 – The New Standard (HEM)

Discussion in 'Loans & Mortgage Brokers' started by Phantom, 5th Jun, 2018.

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  1. Phantom

    Phantom Well-Known Member Premium Member

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    What are living expenses?

    Living expenses play a potentially crucial role in a lender’s servicing calculator. They are generally one part of the serviceability calculator that cannot really be reduced past a minimum floor, but certainly does have the potential to go much higher if applicants declare more than the minimum as specified by each specific lender as generally lenders will take the higher of the two.



    What is the Household Expenditure Measure or HEM?


    A particular method of calculating an applicant’s living expenses has been implemented almost across the board in recent times (estimated to be 70-80% of lenders). This method is called the Household Expenditure Measure (HEM). The HEM is a benchmark lenders use in an attempt to estimate a loan applicant's annual living expenses — this forms part of the overall outgoing figure which in turn makes up part of the calculation that determines borrowing capacity. It was developed by using local survey data, is also linked to CPI and factors in the type of household.


    There are several elements of the HEM which make up the estimated figure for any given applicant. These are:


    1. The city/state in which the borrower lives – e.g. - Sydney & Melbourne are considered to have higher living expenses compared to the other cities around Australia.

    2. Household type – single, couple, family etc.

    3. The number of dependent children;

    4. Lifestyle expenses based on overall spending which is categorised into:


    a) Absolute basics – food, utilities, transport, communication etc.

    b) Discretionary basics – take-away food, restaurants, alcohol, entertainment etc.

    c) Discretionary non-basics – overseas holiday, house cleaner, luxury items etc.


    In simple terms, the purpose of using the HEM is like using lesser used methods such as the HPI (Henderson Poverty Index – which focused on minimum income requirements relative to living costs) in that it assists lenders in make sure they are complying under the National Consumer Credit Protection Act 2009 (NCCP) by taking reasonable steps in determining whether or not a borrower can comfortably afford their loan repayments.



    How Does Income Affect HEM?

    Generally speaking, household income levels have a direct influence on the minimum living expenses calculated figure. Most lenders have a different weighting to how income affects the overall HEM estimate so it is difficult to quantify this across the board. It should also be noted that most lenders also add a non-disclosed buffer over the minimum HEM based on their risk appetite at the time which can be adjusted as their appetite changes.


    In the below example, we will illustrate how the HEM figures positively correlate with income as it increases. We have used a simple single applicant on varying incomes using a major lender’s servicing calculator. Everything else relating to the serviceability calculator is disregarded for the purpose of this illustration.

    [​IMG]



    As can be seen above, there is an obvious positive correlation between income and the lenders calculation of living expenses – as income increases, so do the living expenses. There is a comparatively steep jump from $100,000 - $120,000 & an odd pause in the increase at the $120,000 - $140,000 level for unknown reasons. We also noticed there was a max out to the increasing living expenses. When income reached approximately $240,000, living expenses stopped at about $3,170 per month. Any income above this level did not see an automatic minimum increase in living expenses.


    In another example, we will show a similar scenario but this time we will use a PAYG couple each earning full time salaries.


    [​IMG]


    Here we can see a sharp increase between $200,000 - $240,000 then there is a plateau effect at the $240,000 level where no matter how much more income is earnt, the lender calculated minimum living expenses does not increase past this point.


    As a reminder, it should be noted that although both examples show that after a certain income level, the lender calculated minimum living expenses do not increase – this does not mean in absolute terms that living expenses hit a ceiling. Living expenses do not have a maximum limit when declared by the borrower(s). Lenders will almost always take the higher of the two between their minimum as calculated and the borrowers’ declared amount.



    What’s Next?

    There is also a more recent trend perhaps in response to regulator intervention and the influence of the Royal Commission findings thus far, which is seeing lenders asking for specific breakdown of each expense category for borrowers by providing a borrower declaration or statement. This is likely the beginning of a new phase in highly scrutinised living expenses by the lenders. We have started to see more and more lenders requesting bank statements for the purpose of checking transactions that can be matched with the declared expenses.

    These systems are also being automated by lenders and 3rd parties who have been increasingly investing in software for the purpose of data matching and the auto categorisation of living expenses. This technology is being used already by some major lenders in their websites & phone applications.

    Although not perfected quite yet, it would seem like this is the way of the future as the technology becomes more refined and as the most efficient method of tracking and evidencing living expenses.

    Here is the link for the original article:

    http://www.precisionfunding.com.au/living-expenses-2018/
     
    Last edited: 5th Jun, 2018
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  2. Christina46

    Christina46 Well-Known Member

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    @George Poullos interesting read - thank you. Your examples only include PAYG income. Can you shed some light on how rental income is treated? Is it just any surplus that gets added in? I imagine if all income (not just surplus) it could paint a very different picture.
     
  3. Phantom

    Phantom Well-Known Member Premium Member

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    Hi Christina. We kept the scenario simple for the purpose of the illustration. We have done additional modelling using a mix of PAYG income and rental income - the result is the same at the same total net income levels.
     
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  4. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    Lenders have different policies on how they treat different forms of income (including rental).

    Initially they just added it all up and used that against their indexes. This created the problem where lenders would increase your living expenses every time you purchase an IP, despite that the IP might be negative geared. Not exactly fair.

    Some lenders are starting to recognise this and ignoring rental income for the purposes of living expenses. I'd say for most people this is reasonable, until you consider that some people are at the point where they live off rent. At that point, the rental income probably should be treated as PAYG, but this model suggests it wouldn't.

    Overall I think the relationship between various forms of income and various living expenses has a long way to go. Lenders will need to become more sophisticated in multiple ways. As an example they don't really treat minimum living expenses differently from discretionary, differently from the grey area between the two. You need to put food on the table, but don't need to eat out. You need to travel to work, but can cut transport expenses on the weekend. Where the kids private school fees sit on this spectrum is as much a value judgement as anything else.

    This is probably one area where adjustments may actually improve people's serviceability over time, but for some it could well go in a completely different direction. It's also going to be very different results for different lenders.
     
    Last edited: 5th Jun, 2018
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  5. Christina46

    Christina46 Well-Known Member

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    Yes, this approach certainly wouldn't reflect our living expenses (nor I suspect many people on this forum). Even though we are now positively geared with our current IPs, it's certainly not the full rental income that would be available to use for living expenses (in reality all the surplus plus one of our wages goes towards PPoR offset).
     
  6. beachgurl

    beachgurl Well-Known Member

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    Add those lenders who now require IP expenses to be added in living expenses and borrowing capacities tumble further.
     
  7. Paul@PAS

    [email protected] Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    My single 20yo daughter lives at home. Works 6 days a week and has no major vices eg not a big drinker, or smoker. She has a mobile (prepaid $40pm) and pays for fuel $40 a week. Eats out 2-3 nts a week or a movie. Pays $0 board. Makes her own lunches and even many dinners if she is late home from sport training (4nts a week)

    Lenders say she spends $1350 a month in servicing calcs. She wished she did. She thinks $350 is closer to mark. She saves 80%+ of her net earnings and can prove it. Banks wont accept it and use their own numbers and say she cant save more than 60%...But they have her savings history.

    Banks will wake up soon and realise its like the GFC when they stopped lending.

    When the banks retrench the fools who have introduced all these changes that now prevent loans it will improve.
     
  8. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    Your daughters (banking) horoscope this week says:
    You will soon meet a handsome budding poet/artist who will sweep you off your feet. By July you'll have moved in with him, pay for both of you to travel to Europe for him to study art (in an Amsterdam coffee shop), and come back with a joyous surprise for the family. You'll live happily (broke) ever after.
     
  9. beachgurl

    beachgurl Well-Known Member

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    it's client's like your daughter that my auditor is not loving at the moment. At my last quarterly audit I had to explain why I had numerous clients whose actual living expenses fell under the HEM. I'm not sure whether "they are tight arses" would be terminology they would've accepted.
    Well done to your daughter. She is definitely not the norm these days.
     
  10. Mmm1984

    Mmm1984 Member

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  11. Mmm1984

    Mmm1984 Member

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    Hi

    I saw on here the other week someone posted an updated bank HEM sheet by state and dependents.

    Can anybody point me to this post?

    TIA
     
  12. Mmm1984

    Mmm1984 Member

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