How to calculate home loan living expenses

Applying for a home loan? Before you make an appointment with the lender, make sure you’ve calculated your living expenses.

In the past, lenders used benchmarks and estimates to assess your ability to repay. Today’s lending landscape has changed. Banks now want to see your actual expenditure before they decide whether or not to lend to you.

We look at the why, what and how of calculating living expenses so you can go into that meeting with confidence.

Why are your living expenses important?

Your ability to meet your mortgage repayments is affected by how high your income is, but also by how high your other living expenses are.

What do banks look at when assessing your living expenses?

Banks use a combination of methods to measure your living expenses. These include:

• The Household Expenditure Method (HEM)
• Self-assessed living expenses
• Bank statements and financial records

Household Expenditure Measure

The Household Expenditure Measure (HEM) is a standard benchmark developed by the Melbourne Institute in 2011 that:

• estimates your living expenses based on a number of variables including income, family size, location and lifestyle
• almost always underestimates real living expenses
• was relied on heavily by lenders

Today, the HEM is still used. However, banks no longer rely solely on this benchmark. Instead, they look at your actual living expenses.

Self-assessed living expenses

You will be asked to assess your living expenses. Banks will then look at the assessment and check it against your bank statements. If your self-assessed expenses are a lot lower than the HEM, you may be asked to explain why.

Some common areas that people underestimate or forget to include:

• Large irregular expenses, like private school fees or annual memberships
• Discretionary spending on eating out, travel and leisure
• Loan repayments, especially novated leases where the money is deducted straight from salary

Banks are more aware than ever before that people may be under estimating their expenses. Doing so deliberately is a red flag to the bank that you are a high risk borrower. That’s why it’s important that you try and be as accurate as possible.

Financial statements

To lessen the risk that people will underestimate their spending, APRA has brought in regulation that requires lenders to look at real expenditure. This is supposed to give banks a more realistic idea of what applicants can really afford to borrow. Lenders now look at your actual bank statements to find out what they need to know.

They’re considering things like:

• Spending on recreation, entertainment, medical and health
• Regular expenditure like Netflix, and weekly Friday night pizza
• Whether your statements match your declared living expenses

Lenders also have far greater access to information than they used to. The advent of Comprehensive Credit Reporting (CCR) has meant increased sharing across institutions. If you have missed a credit card payment with a different bank, your new lender will know about it.

Your financial preparation checklist

Before you start ironing a shirt for the all-important meeting with the bank, check that you’re prepared. Ask yourself:

Do I know what I’m really spending?

• Download a copy of all your bank statements for at least the last six months.
• Include annual or semi-annual expenses that might otherwise be missed.
• Enter your spending into a budget spreadsheet. To make it easier, there are several digital apps that will link directly to your bank accounts.

Are there areas where I can improve?

• Identify where your money is going. You might be surprised at what you’re spending!
• If there are any unusual large expenses, make sure you can explain why they were needed
• Find areas to cut back. It could be as simple as bringing your lunch to work or cancelling those subscriptions you forgot you had.
• Decide whether to focus on paying down debt or saving for a deposit.

What do my spending habits say about me?

• Banks consider ZipPay and AfterPay as an indication that you’re spending above your means.
• Late fees or penalties, even if they’re not defaults that affect your credit file, are another red flag.
• Spending at the TAB or on gambling apps will definitely raise alarm bells, so try to avoid these.

Got the ball rolling with a finance application? Get in touch with our offices and let us know what types of property you’re looking for. We’ll let you know as soon as a home comes on the market that fits your requirements.

*Independent is not a financial advisor. The information contained is for general information purposes only. It is not intended as legal, financial or investment advice and should not be construed or relied on as such. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before making any commitment of a legal or financial nature you should consider the appropriateness of the information having regard to your circumstances and needs and seek advice from a legal practitioner or financial or investment adviser.