By Philippe Brach, CEO, Multifocus Properties & Finance
During the golden days of home lending, banks would ask prospective borrowers to declare their basic living expenses, and then they would compare these to the Household Expenditure Measure (HEM) – a table detailing average expenditure per household, broken down by state or territory, number of dependents and lifestyle costs.
The bank would check the customer’s declared expenses against this benchmark, then use the higher of the two to determine if they could comfortably service the loan.
However, after the intense scrutiny of the Royal Commission, banks are now doubling down when it comes to borrowing power and loan serviceability. While this won’t impact those whose expenses come in at well under the HEM figures, it’s very frustrating for everyone else – as every single cent we spend could now be analysed when we apply for a loan.
I completely understand the need to crack down on irresponsible lending, and it’s true that the HEM can be inadequate when used as the key deciding factor for approving loans as it doesn’t take into account individual circumstances and deviations from the norm.
I’m sure that during the property boom glossing over applicant’s real-life expenses and pushing through hasty approvals has meant that many people who really don’t have the ability or willingness to repay their debt have been loaned vast sums of money, but those circumstances are the exception not the rule. Most of us are more than capable of reigning in our expenses when the need arises, especially if it means achieving the Great Australian Dream of home ownership or buying an investment property.
The problem, as I see it, with this new crackdown is it doesn’t give borrowers any credit as savvy money managers. It assumes that you’ll continue spending $10,000 a year on ski gear or $300 a week on Uber Eats, even if money becomes tight. It doesn’t allow for the fact that for most people, luxury expenses like holidays and takeout are costs that can be trimmed if they seem like they could impact on your ability to pay your home loan.
There are certain fixed expenses: those regular costs you can’t really get away from, such as utilities, phone & internet bills, school fees, health insurance, groceries, fuel, etc.
Then there are discretionary expenses which can be cut to a minimum if the need arises. This includes items such as Netflix/ Foxtel, dining out, holidays, alcohol and other non-essential spending.
The banks don’t distinguish between these two types. They assume that you’ll continue spending as you were before you applied for the mortgage and, in some circumstances, this can make it almost impossible for you to prove you can service the loan without putting yourself under financial stress.
Another important thing to note is that we’re often talking about borrowers who well and truly earn enough money to meet the monthly repayments, they just have more lavish lifestyles than the bank might like.
So it’s not a case of loaning money and watching them slip into poverty, unable to feed or clothe themselves. Rather, it simply means they may have to trim the luxuries a little and funnel that cash into their home loan repayment if the need arises.
A recent Federal Court case between ASIC and Westpac underscores my point. ASIC’s claim was that Westpac had not taken reasonable steps to ensure their customers could afford their home loans. Between 2011 and 2015 they used an automated system to approve more than 260,000 loans, which determined serviceability by using the HEM rather than customers actual expenses.
There was no evidence that any of these customers had experienced hardship or defaulted as a result, but this didn’t stop ASIC from pursuing the charges. However, the judge agreed with my rationale that borrowers are more than capable of making cutbacks when and if required, and so dismissed the case.
The fact is, Australia has consistently had mortgage delinquency ratios among the lowest in the OECD. The evidence speaks for itself – we know how to pay back a loan! Which means we must be able to manage our finances and change our habits when required. If we want our own home badly enough we’ll forgo the daily lattes and annual trips overseas.
It’s a controversial topic; with some experts claiming that if borrowers cut their budgets in order to afford higher loan repayments, our economy could suffer. Others believe that saving a deposit while paying rent is difficult enough in itself, and this new scrutiny on borrowers seems like another unnecessary hurdle that could prevent hardworking, responsible Australians from obtaining a home loan.
Overall, we went from a fairly easy treatment of living expenses by lenders – called basic living expenses at the time - to a comprehensive analysis of every single dollar spent by borrowers, with the obvious result that it is now a lot harder to get a loan. Hopefully the pendulum will swing back to somewhere in the middle. Surely common sense must prevail at some stage.