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How living expenses can impact your borrowing power

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When you’re applying for a mortgage, lenders don’t just look at your income, your deposit and your equity to see if you can afford the loan repayments.  They also look at how much you spend each month on items such as groceries, transport and utilities. As a result, these day-to-day living expenses can play a big role in determining how much money you can borrow and your chances of being approved for a home loan.

Why are living expenses so important?

By law, lenders are required to meet ‘responsible lending’ guidelines. This means they need to take reasonable steps to ensure that a borrower can afford to repay a loan without falling into ‘substantial hardship’. To help them assess this, lenders look at how much of your income is left to repay the loan after all your regular living expenses have come off.

How do lenders calculate living expenses?

Many lenders use the Household Expenditure Method (HEM) to help them calculate the living costs of applicants. The HEM is a benchmark figure that estimates how much someone in your location is likely to spend on living costs, taking into account family size and the number of children you have.

As the HEM is an estimate, lenders may want to get a more accurate picture of your individual living costs. To do this, they may ask you to declare your living expenses on your application form. These might then be reviewed against your bank account and credit card statements. Your stated expenses are then compared with the HEM calculation. The lender may then take the higher figure of the two to work out if you can afford the loan.

How is the HEM calculated?

The HEM is made up of several different elements including:

  1. Location – this is because someone living in a city like Melbourne or Sydney will usually have higher expenses than someone in a rural area
  2. Household size – if you are single, a couple or a family
  3. The number of dependents –  the more children you have, the higher your living expenses will be
  4. Lifestyle expenses – these are categorised into absolute basics, discretionary basics and non-basic luxuries

Absolute basics are necessary expenses such as bills, groceries, transport, and medical costs.

Discretionary basics are expenses such as eating out, alcohol and entertainment, which are not necessary on a day-to-day basis. Buy-now-pay-later services like Afterpay fall into this category.

Overseas holidays, gardening and residential cleaning services would be considered non-basic luxuries.

How keeping a track on your spending can help

If you are thinking of applying for a home loan, it can be a good idea to start tracking your monthly spending well in advance of your application.

This gives you a clearer picture of your spending habits and may highlight items you can cut back on such as takeaway coffee and lunch out.

Once you see where your money goes, plan and stick to a reasonable budget. This is a great way of taking control of your money and could put you in a better position when you apply for a home loan.

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