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The Royal Commission and the Australian Prudential Regulation Authority’s (APRA) calls for sound lending practices has put living expenses under the spotlight. Where once it was enough to estimate roughly the cost of living, lenders are increasingly asking for itemised and verified breakdowns of ongoing household expenses.
While it may be a daunting task to list all your living commitments in detail, it’s a worthwhile exercise. Adding up how much you spend each week on groceries, transport and utilities is a valuable insight into how hard or difficult it is to meet your mortgage repayments.
Under the National Consumer Credit Protection Act 2009, Australian lenders must make allowances for living costs when they assess your borrowing power for a mortgage application. This requirement is still in place but what has changed is the level of scrutiny. Living expenses must now be accurately gathered and verified to ensure they make sense and are in keeping with your personal and financial circumstances.
Itemise your expenses
Do you know how much you spend on running a car or buying clothes? These are the type of details you may now need to know when applying for a loan. Rather than bundling living expenses as a single cost, lenders are requesting applicants break their costs down into formal categories. Examples include:
- clothing and personal care
- groceries and food
- medical and health
- recreation and entertainment
- communication (telephone, internet, pay TV and media streaming)
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Your expenses and declared income are verified using three months or more of payslips, recent bank transaction and credit card statements. If your declared living expenses are significantly lower than your monthly credit card spend, expect questions about the discrepancy. If the lender queries items, further justification may have to be provided to prove discretionary expenses are one-off or can be cancelled if required.
Above and beyond these basic expenses, you may be asked to provide evidence of additional financial commitments. For example, rent payers may have to supply letters from the property manager or signed and dated rental agreements. For those with child support or existing debt obligations, be ready with bank statements, transaction listings, court orders or child support agency letters.
You may also be asked to sign a financial acknowledgement confirming the reliability of the income, expenses and liability information you have supplied.
The use of benchmarks
Many lenders have traditionally used a benchmark known as HEM (Household Expenditure Measure) as a guide to the household expenses of a typical couple or family. HEM takes into account the state you live in and the number of dependents in your family. On top of the HEM benchmark, lenders often add a buffer to safeguard against borrowers potentially running into financial difficulty should interest rates rise.
When a borrower supplies an estimate of their total living expenses, the lender compares this to the HEM estimate and takes the higher of the two figures to calculate borrowing power.
The HEM has been criticised for its unrealistically low estimates. While many lenders continue to use this benchmark, it has recently been altered to include more items that might contribute to a higher cost of living, such as petrol, rent and road tolls. Work is also underway to design a new benchmark that complies with APRA’s sound lending practices guidelines.
Take the hassle out of this new approach to living expenses by seeking the advice of an experienced mortgage broker. Your Yellow Brick Road representative can help you with all the essential details like handling the paperwork and knowing which lenders offer lending criteria suitable to your needs.