Article by Patrick Lynch, Head of Operations at Long Property
The loan approval process has become progressively tougher with the impact of regulatory intervention leading to tighter lending policy and longer assessment times. In addition, where previously Lenders primarily focused on income verification, with a limited review of outgoings beyond debt obligations, we are now seeing more attention on living expenses. So why now, and what does the future hold?
Background – Household Living Expenses and HEM
Historically, an aggregate ‘household living expenses’ figure was documented and advised to the Bank following discussions with Clients. But who can accurately say what they spend each month? I’ve seen friends shocked when presented with their actual expenditure. It can also be extremely difficult for sole traders to separate business and personal expenses when using only one transaction account.
The Bank’s approach, consistent with what was considered appropriate, would compare this guesstimate with the ‘Household Expenditure Measure’, i.e. HEM, a minimum monthly figure based on a Client’s circumstances, i.e. married or single, number of dependents, home location, etc.
The greater of the two figures (aggregate stated expenses, or HEM) would be used in assessing serviceability. Over time, HEM increased in an attempt to become more ‘accurate’. Now, most Lenders are requiring information on over 10 categories of living expenses, for each loan application.
We’re now additionally seeing Lenders request 3 months’ statements for a Client’s primary personal transaction account, not just to confirm income or undisclosed debt, but to check line-by-line the accuracy of living expenses put forward on the application. This is all part of the industry’s response to meeting its responsible lending obligations and complying with the National Consumer Credit Protection Act (NCCP).
Of course, what someone spent in the last quarter may not reflect annual expenses or future spending. Spending is elastic and influenced by factors including loan interest rates. Indeed, Clients are likely to cut discretionary expenses such as entertainment rather than default (fail to meet repayments) on a loan.
Future of Living Expenses verification
The Royal Commission has asked should HEM continue to be employed to benchmark living expenses, querying whether the processes used by Lenders adequately meet the requirements of NCCP.
Should HEM be abandoned? It is a useful estimate, but just one of various sources to assist with reviewing financial circumstances.
Banks and Lenders will be conscious of balancing the need for responsible lending with credit growth, market share, and shareholder sentiment, and this may see movement in other areas of assessment, e.g. stress-testing at a lower interest assessment rate.
We don’t want to interrogate Clients, but we do have an obligation and opportunity to educate where spending might prevent them from applying for a suitable loan. Being too harsh on the assessment of expenses may restrict Clients wanting to refinance, even though they may currently be making higher loan payments on their current loan, and that doesn’t make sense.
The additional effort to cross-examine expenses will increase the workload on Brokers and Lenders beyond the longer time already being spent dealing with tighter lending policies.
Example
Recently, a Client wished to refinance their loan. The Lender noted that provided bank statements showed a greater amount of living expenses than disclosed. We reviewed the statements, spoke with the Client, and reverted to the Lender – the explanation was changed utility providers (the assessor had partly double-counted) and a different property use (previously ‘home’, now investment). The final living expense figure used for assessment had to be increased slightly, but the outcome was that the application got approved exactly as submitted.
Here are the 13 categories of living expenses most Lenders are now interested in.
- Owner-occupied property costs
- Clothing and personal care
- Recreation and entertainment
- Transport
- Investment property costs
- Groceries
- Rent
- Insurance (life, health, etc.)
- Medical and health
- Childcare
- Education
- Connections (mobile, internet)
- Other
Summary
It is important that all parties have a clear understanding of the Client’s financial situation, as this will ultimately lead to a more secure banking system, which everyone benefits from.
