Become a Creator today!Start creating today - Share your story with the world!
Start for free
00:00:00
00:00:01
How Do Banks Verify Your Living Expenses?
130 Plays18 days ago
Learn how banks use your living expenses to determine whether you qualify for a home loan. We break down the HEM benchmark, explain what spending habits raise red flags, and share tips on cleaning up your finances before submitting your application.
Want to take charge of your mortgage and build wealth? Get a free home loan health check from Hunter Galloway – the home for homebuyers. Visit huntergalloway.com.au or call 1300 088 065.
Recommended
Transcript
Understanding HEM and Its Role in Loan Approval
00:00:00
Speaker
Hem. Not the edge of your sleeve. Hem is the key factor that could make or break your home loan application. Before you apply for a home loan, the banks are scrutinizing how you spend your money. And what do you do if your home loan application gets declined if your living expenses are too high? Don't worry. I'm going to walk you through some simple tips to review and reduce your spending. Potentially challenge a negative decision from your bank and look at what expenses are complete red flags when you're looking to apply for a home loan.
Introduction to the Podcast and Housing Market Tips
00:00:24
Speaker
So whether it's canceling some streaming or spending some more time cooking at home, I'm going to show you how to get your finances back on track and increase your chances of getting your home loan approved. Welcome to the Buying Your First Home Podcast, your personal guide through the Australian housing market. Here we tackle the big questions and the small details that come up when buying your first home. From financial prep to finding the right neighbourhood, we're here to ensure that you've got all the knowledge at your fingertips. So let's take the first step towards unlocking the door to your new home.
Impact of Living Expenses on Borrowing Capacity
00:00:59
Speaker
Alright, so why do living expenses actually matter? Banks work at your borrowing capacity based on how much money you've got left over after all your expenses. Here's a pretty simplified way of looking at it. When calculating your borrowing capacity, the banks start with your income. Let's say you're on a $100,000 salary a year. They then subtract how much you pay in tax.
00:01:15
Speaker
You might pay around $23,000 in tax, so it leaves you with $77,000. Then they subtract your living expenses. That includes things like rent, groceries, utilities, et etc. So this example, it's pretend your annual living expenses are $33,000. You've got $44,000 left. They take off any other debt, so if you've got a personal loan, for example, taking off another $7,000 leaves you with $37,000 left.
00:01:34
Speaker
net at the end of the year to pay for your loan. This leftover money after your tax expenses and liabilities leaves you with how much you can potentially afford to make with your loan repayments. But my point is, as you can see here, the living expenses are a massive part of this overall borrowing capacity equation. The crazy part of it all is an extra $5,000 in net income can potentially increase your borrowing capacity by 20 to $30,000. So having your accurate living expenses can be the make or break to you buying your dream home.
Development and Components of HEM
00:02:02
Speaker
But how do the banks determine all these living expenses? Well,
00:02:04
Speaker
This is where HEM comes in. HEM is the Household Expenditure Measure. It's a critical benchmark in helping the banks understand whether or not you can afford your home loan. It's been developed by the Melbourne Institute of Applied Economics, but banks use HEM as a bit of a financial yardstick to estimate your living expenses and ensure that you're not borrowing more than what you can actually handle. HEM covers two main expenses. Firstly, your basic essentials. These are non-negotiables like groceries, utilities, transportation costs. It's the bare minimum you need to get by. The secondary is discretionary spending.
00:02:31
Speaker
This is kinda the fun stuff. Entertainment, dining out hobbies, it's also worth mentioning what's not included in HEM. Your rent, existing mortgage repayments, private school fees, gambling and other significant costs don't form part of this HEM. Banks will consider these expenses separately when calculating your loan application and they'll potentially further reduce your borrowing capacity.
00:02:49
Speaker
So, after all that, you might be wondering, well, how do the banks actually calculate this hemp figure? Well, it's not a one-size-fits-all number. Hemp takes into account your income level, the size of your household, and where you actually live. Let me show you a real example. Say you have two couples living in Sydney. Each household earns about $180,000 a year before tax.
00:03:06
Speaker
but One couple has two kids and the other has no kids. The couple has two kids have a hem of about $60,000 per year. This leaves them with 80 grand left over potential mortgage repayments. The couple without kids, their hem will be lower. The total annual costs are closer to $50,000. That extra $9,000 to,000 goes in available funds for their borrowing capacity, which increases their borrowing power by almost $100,000.
Balancing HEM and Self-Assessed Expenses
00:03:29
Speaker
Two kids, 100 grand,
00:03:30
Speaker
Yeah, it seems crazy, but that's how it works. HEM adjusts based on your circumstances as not just how much you earn, but it's also your family situation. And this is where it gets a bit more interesting. Banks don't just rely on HEM alone. They'll combine this with your self-assessed living expenses when you apply for a loan. When you apply with your mortgage broker or direct to the bank, they'll generally want you to have a detailed breakdown of your expenses. The bank then compares your self-assessment with the HEM benchmark.
00:03:51
Speaker
But don't think you're going to be able to load all this and get a bigger loan. Banks do have ways of verifying your spending habits. They'll go through your bank statements, your credit card statements, and make sure things line up. They're going to be broadly looking for consistency between what you've declared and what you're actually spending. Let me give you an example. By this client, let's call it Sarah, who came to us after being knocked back from a bank. Sarah declared her monthly food and living expenses is just $500 for a family of four. When she applied direct for the bank, it raised some instant red flags and they requested to see her actual statements.
00:04:19
Speaker
When they saw her actual statements, she was spending over $1,200 a month on groceries and dining out. The bank then automatically adjusted her expenses upward. It reduced her borrowing capacity and ultimately led to her application being declined. This is where working with the mortgage broker like us at Hunter Galloway can help out.
Importance of Accurate Spending Reports
00:04:33
Speaker
We would have picked up this discrepancy early in the process and been able to work with Sarah to potentially adjust the spending habits or ensure her living expenses were correctly categorized. Some of those were able to go to discretionary expenses and they could reflect her actual spending.
00:04:46
Speaker
Which might get you thinking, well, can't I just cut back of my expenses right before I apply for a loan? And you can definitely look to reduce your discretionary spending, but remember, banks will typically look at your spending patterns over the last three to six months. So any changes need to be sustained and reflected in your bank statements over a period of time. And this brings us to another pretty important part, the accuracy of your self-assessment.
00:05:04
Speaker
It's important to be as honest and thorough as you can when you're going through these living expenses even when you're working with your broker. Understanding them might seem like a good idea but the banks do have their benchmarks that they need to stick to and you need to be within a couple of percent of what they're expecting. Not just that practically if your expenses are really high, you've understanding them to get your loan approved and you end up getting a bigger loan than you can actually afford, you could end up putting yourself for more financial stress. It's all going to come down to your personal circumstances. I always get this question come January when people are looking to apply for a Home loan, it's a new year, you're getting really excited. And I spoke with Mike earlier this year and he had this exact same situation. He'd gone away to Europe over Christmas, spent a little bit too much over the Christmas break, and then was worried if he was applying for a home loan in January, if the bank was going to pick up on his statement and cause issues when we look to apply. When I reviewed his application, we were able to point out and specifically say to the bank, well, these were one-off expenses. He's not planning on going to Europe any time in the future now he's going to own a home. And a lot of these one-off expenses at Toys R Us and things were for his nieces and nephews, not his actual kids.
00:05:58
Speaker
Once we extrapolate that, we can actually find some extra borrowing capacity which he was able to use to buy his home. So if you are assessing your living expenses, it's important to look at some of the regular things, maybe you like a gym membership, but if it's one-off expenses, we can easily explain those away. And it's crazy how big your differences can make.
Preparing Expenses Before Loan Application
00:06:13
Speaker
Let's say you're eyeing a $600,000 home At Hunter Galloway, we always recommend doing a thorough review of expenses before we apply for the home loan. We'll generally go through your statements, make sure it's all looking good, check your credit file obviously, to make sure you're in a position to comfortably afford the home loan. Now, when touched on the legal case, it's had a big impact on how the banks assess your living expenses. It's known as the Wagyu and Shiraz case.
00:06:32
Speaker
In 2019, Asik took Westpac to court over the use of the HIM benchmark instead of the borrower's actual expenses. The case got its name from a comment made by the judge. He essentially said that just because someone enjoys eating expensive beef and wine doesn't mean they need to cut back on their luxuries just to meet their mortgage repayments. Interestingly, the court ended up ruling in Westpac's favor, saying that the banks could use their discretion when assessing expenses.
00:06:53
Speaker
They said it was reasonable to assume that borrowers might cut back on discretionary spending to afford a mortgage. So since that case, we have noticed the bank's giving a bit more flexibility in how they assess living expenses, in particular those discretionary ones. But the key takeaway is just be prepared to justify your spending if the bank or your broker questions you about it. It's just a part of the process. Don't take it personally. We just need to be able to tick that box for the bank and explain what's going on.
00:07:15
Speaker
I'm also often asked what happens if you're much, much below the hem if you're happy to live this simple life. Be frugal, you don't eat out, maybe have very few subscriptions, no Netflix, that sort of thing. And that's amazing, but unfortunately, the banks will still apply this hem across the board. Let's talk through some practical tips on how to prepare your living expenses for your mortgage application. I think firstly, start by reviewing your expenses way before you plan to apply for the loan. I'm talking three to six months in advance. Go through your statements with a fine tooth comb and look at areas where you might be overspending and look where you can cut back. You don't need to get too overcomplicated, you can literally just open up a spreadsheet, categorize your expenses and look at where you can potentially cut back. The second thing you can do if you're not too handy on a spreadsheet is use an online budgeting tool.
00:07:51
Speaker
I'd recommend looking at YNAB or Good Budget as
Role of Brokers in Loan Application Process
00:07:53
Speaker
a pretty simple one that just scrapes your statements and looks at the expenses, making this a bit easier process. Thirdly, once you've got a clear picture of your expenses, start thinking about how you can improve your financial profile. This could mean reducing discretionary spending, paying off small debts, or building up your savings. Remember, banks look at the recent history, so the sooner you make these changes, the better. Fourth, be meticulous with how you categorize things. It's amazing how much all those little small things can add up and the odd coffee here, a sushi roll there can accumulate to be hundreds, if not thousands of dollars by the end of the year. It can feel overwhelming but potentially if you're having a coffee every day, maybe cut it back to every other day and then once a week to help ease back on some of these expenses. Next, when it comes time to apply for the home loan or speak to the broker, just be prepared to explain any unusual expenses or spending patterns.
00:08:34
Speaker
And lastly, if you're self-employed, be extra careful with separating your business and personal expenses. The banks will want to see a clear distinction between the two. Remember, the goal here isn't to make your expenses look as low as possible. The goal is to present an accurate and realistic picture of your financial situation. If you approve for a loan with unrealistically low living expenses, you could struggle to make repayments down the track.
00:08:52
Speaker
This is where working with a mortgage broker like us at Hunter Galloway can be really valuable. We've seen countless loan applications and we know what banks are looking for. We can present your expenses in a way that's both accurate and favorable for your application. Yeah, I remember this couple I helped a couple of years ago who were both self-employed. Their business expenses were getting mixed up with their personal ones, which was making their living costs look a lot higher than they actually were. They didn't realize this would impact their application because they thought, well, it's a business expense and that's, you know, it's all the same thing. But unfortunately for the banks, it's not that simple.
00:09:18
Speaker
So let's assume you've cleaned up your statements, it's all looking clean and tidy, we're getting ready to prepare and approve your application. So what happens after I've actually submitted it to the bank? The bank's going to review your declared expenses and compare them to your statement. If there's any big discrepancies, they're going to come back to us with questions. And don't panic if that happens, it's a pretty common part of the process where there can be a bit of back and forth between your broker and the bank to try and get to your loan approval. Typically, if we've had that conversation with you, we'll have given the bank a set of loan notes that say, well, this is Raleigh statements, this is what's happened here, this is what's happened there, bit of traveling, you know, there's private health care, it's been cut back to a basic kind of cover, etc, etc, and we can work through to get the right outcome for you.
00:09:55
Speaker
So wrapping up, understanding how the banks calculate and verify your living expenses is an important part of the home loan process. It's not just about ticking boxes in the form, it's about presenting an accurate and comprehensive picture of your financial situation. Just remember that banks aren't trying to trip you up, they're required by law to lend responsibly, which means ensuring you can afford your home loan payments without falling into any financial stress. At Hunter Galloway, we're here to help you through every step of the process. We review your expenses and try and identify areas for improvement. We want to help present your application in the best possible light. So if you think about applying for a home loan or if you're looking at doing the future, don't do it alone.
Conclusion and Support from Hunter Galloway
00:10:27
Speaker
Reach out to us at Hunter Galloway, we'd be more than happy to us assist. As a part of our process, we'll look at your income, expenses and overall financial situation and give you a clear picture of what you'll actually be able to borrow.
00:10:36
Speaker
Thanks for sticking with me till the end. I hope you enjoy this deep dive into living expenses. Like I said from the top, Ham's a funny one where it means so much when you're applying for a home loan, then it doesn't really matter anymore once you've got it. So if you need any help navigating Ham, the living expenses, hit us up at huntergalloway dot.com.au. We'd love to help out. Until next time, I'll see you guys later.