Procedures, requirements and guidelines in the Australian finance industry continue to change on a near-daily basis.
Why is the industry changing so often? Government agencies like ARPA and ASIC are pressuring banks to tighten guidelines, specifically with calculations and assessments related to living expenses. Due to this increased pressure, some applicants see 40 per cent reductions in their borrowing capacity.
The Specific Changes This Pressure Brings
Currently, banks and financing firms use the HEM, or the House Expenditure Measure, to calculate a prospective applicant’s expenses; it’s a figure that will directly determine that applicant’s borrowing capacity.
The UBS, a global financial firm, estimated that up to 80% of lenders used the HEM to calculate living expenses; they also feel that some lenders are abusing the HEM to lend more than they should.
Wait, why is this an issue?
The HEM uses a few different things to calculate living expenses. Some examples include:
- How many dependents/children the applicant has
- An applicant’s lifestyle and how much they spend on it
- The current location of the applicant and the average expenses for that area
Doesn’t sound bad yet, so what’s wrong? The issue lies with how the HEM calculates lifestyle expenses and how lenders use it to change an applicant’s borrowing power; each applicant’s lifestyle and spending habits are split between four categories, these are:
How Different Lifestyle Measures Change Lending Power
Most banks were using the basic lifestyle assumption in 2017. A “basic” lifestyle means that the applicant is making roughly $80,000 a year with $32,400 in expenses.
As an example of how this changes an applicant’s lending power, you would be able to borrow a maximum of $337,985 if a lender assumes the applicant is in the basic lifestyle measure category.
Meanwhile, the “lavish” lifestyle measure significantly reduces an applicant’s credit availability.
For example, lavish lifestyle expenses would be defined as $80,000 of annual income with $50,000 in expenses. Most banks would give an applicant living in lavish conditions a maximum of $195,912, which is about a 40% decrease in lending power.
What the Government Wants Lenders to Do With the HEM System
The government currently feels that too many people are in the basic lifestyle measure when they should be in the lavish or moderate lifestyle measures. Because of this, the government wants lenders to have stricter definitions and guidelines in the HEM for both the basic and lavish measures.
Why This Could Be Bad for Both Lenders and Borrowers
So, is this a good thing or a bad thing?
Well, it’s a mix of both, although this protects some applicants who could end up getting bigger loans than they can pay, it could make things harder on others.
It’s fair to assume that most applicants fall under the basic lifestyle measure, so that’s why so many banks and firms were using that bracket during the lending process. This means that most lenders were using the measures correctly during the lending process and this pressure from the government makes things harder for them, even if they were correctly handling the borrowing process in the first place.
It also hurts the average person looking for a loan. Guidelines changing due to government pressure could make the loan process take longer. They’ll also reduce how much some people can borrow, which could prevent them from getting a house or a car.
How are Banks Are Adapting to This Pressure and Becoming More Responsible?
This isn’t all bad though. In fact, it’ll help borrowers and lenders get healthier estimates and help brokers develop unique financing strategies for each client.
Quantum Finance Australia is using this opportunity to understand each client’s situation; we also offer tons of lending options that can fit any situation.
This entire situation makes the whole financing process more responsible. Lenders have already established an IWG, or Industry Working Group to develop a new benchmark that will comply with APRA’s guidelines for sound lending practices.
Regulations still haven’t hit lenders, but they could be coming faster than many think. Most are thinking that banking royal commission will impose restrictions on the HEM or request an entirely new calculation system, but it’s hard to tell what will happen for now.
A reasonable assumption would be that the lavish and basic lifestyle measure will both change to some degree. Lenders have already changed how these work by scaling the living expenses to income in the lavish measure while freezing basic lifestyle expenses for every income bracket.
Overall, lenders are becoming more responsible, and borrowers are getting more reasonable loans because of these changing guidelines.
So, What Expenses Will Lenders Take Into Account?
Regardless of the pressure, the government is bringing and the possible regulations that will come, this won’t really change.
Some basic things a lender will look at when calculating expenses include:
- Fixed living expenses like rent and mortgage payments
- Variable living expenses like utility costs and food
Other costs that lenders may inquire about are:
- How often a borrower orders food instead of making it themselves
- How much a borrower spends on entertainment
- How much a borrower pays on alcohol
- How much a borrower pays on tobacco
- If a borrower gambles and if they do, how much they spend on it
However, these are just basic guidelines. Each lender will have their unique method of assessing expenses to meet these guidelines. Some will take a real “deep dive” into each applicant’s expenses to ensure they’re a fit for the loan while others are less strict and only look at the basics.
As an example of this, some lenders consider gym memberships or television subscriptions to be living expenses while others don’t. This is because these expenses are easily cancelled, not essential and could be considered “one-time expenses” if a borrower verifies they have cancelled them.
Other examples of expenses that could vary in identification with each borrower include:
- Magazine subscriptions
- School fees
- Internet subscriptions
- Wine clubs
- Travel costs
Overall, some lenders will want a complete view of an applicant’s lifestyle while others are more lenient. Most will also check if individual or “one-off” expenses will affect a borrower’s ability to pay.