When applying for a home loan it’s important to understand how lenders assess your borrowing capacity. Among the various measures used, the Household Expenditure Measure (HEM) plays a pivotal role. The HEM helps lenders to gauge a borrower’s living expenses in relation to being able to make home loan repayments and is designed to protect borrowers and lenders alike. Let’s explore what the HEM is and how it affects borrowing capacity.
What is the Household Expenditure Measure (HEM)?
The HEM is a benchmark that lenders use to estimate a borrower’s basic living expenses in view of the home loan they’re applying for. The HEM is based on data from CPI and ABS survey data, representing an average household's living expenses across different eight income levels and household sizes.
The HEM is designed to ensure applicants have enough income available after regular expenses to service their mortgage. By factoring in living costs, the HEM protects both borrowers and lenders from overstretching finances, which helps to prevent situations where borrowers may struggle to meet their repayment obligations.
Why do lenders use the HEM?
Lenders use the HEM because it standardises how a borrower’s expenses are calculated. Instead of relying solely on the expense amounts a borrower reports—which are often underestimated—lenders can cross-check those amounts against the HEM to ensure they reflect a realistic assessment of living costs.
The measure was developed to simplify the credit assessment process to ensure home loan applicants are judged fairly. Since borrowers’ self-reported expenses can vary significantly, using the HEM offers a baseline to evaluate whether a borrower's reported expenses are reasonable.
How does the HEM impact borrowing capacity?
The HEM plays a crucial role in calculating borrowing capacity, which is the maximum amount you can borrow based on your income, debts, and expenses. Here’s how it works:
- Verify expenses. Declared living expenses are compared to the HEM benchmark. If expenses are reported at lower amounts than the current HEM, the lender will use the HEM figure instead.
- Income considerations. Lenders consider how much of an applicant’s gross income will be used for basic living expenses (against HEM benchmarks), existing debt commitments (credit limits), and other financial obligations. The balance is then allocated to mortgage repayments, including interest rate buffers to allow for possible interest rate increases.
- Household and lifestyle factors. The HEM is scaled for different household sizes depending on if applicants have dependents, marital status, and property location. For example, a single person will have a lower HEM benchmark applied than a couple with children.
The HEM covers essential spending that’s non-discretionary and a small extent of non-essential spending that’s deemed as discretionary. The HEM is updated periodically, usually in line with ABS data and inflation increases but not with interest/cash rate increases. The HEM isn’t publicly available, but we can tell you as mortgage brokers who broker finance from a large panel of lenders, the HEM generally covers the following:
- Food and groceries.
- Utilities—electricity, water, gas, heating, and cooling.
- Housing costs—rates, water, repairs and maintenance.
- Communication and media—phone, internet, and TV/streaming services.
- Transport—fuel, public transport, and vehicle maintenance.
- Health—insurance, medications, and medical appointments.
- Clothing and footwear—everyday wear, shoes, and basic accessories.
However, the HEM doesn’t factor every type of living expense. For example, the HEM doesn’t include:
- Private school fees.
- Life insurance.
- Sickness and personal accident insurance.
- Superannuation.
- Alimony/spousal support or maintenance payments.
- Interest repayments on loans.
- Lease payments.
- HECS-HELP debts.
The HEM previously covered body corporate levies/fees for strata properties in the ‘housing costs’ category, however there were some issues around the benchmarking and potentially being ‘double counted’ through other categories/calculations.
By understanding how the HEM affects borrowing capacity, applicants/borrowers can better prepare for the home loan application process. In working with a broker to get pre-approval, bank account statements are required to calculate and demonstrate borrowing capacity. Loan applicants should review statement activity for any one-off expenses such as an emergency vet bill or a home maintenance expense and list those costs ready for your mortgage broker to properly factor into the borrowing capacity equation.
Of course, there’s many other factors that affect borrowing capacity such as:
- Your credit score.
- Credit facility limits.
- Home loan deposit requirements (loan-to-value ratios).
- Lenders mortgage insurance.
- Income and/or employment history in terms of stability. Self-employed applicants are subject to a range of other factors/lending tests.
Your broker at Get Real Finance will guide you through the loan application process and how to improve your borrowing capacity to be in the best position to be ‘loan ready’.
