Understanding HEM: What You Need to Know About the Household Expenditure Measure and Its Impact on Your Home Loan

When applying for a home loan, lenders assess your financial position to determine your ability to repay the loan. One critical component they use is the Household Expenditure Measure (HEM). But what exactly is HEM, and how does it affect your borrowing capacity? This article unpacks everything you need to know about HEM and offers tips to ensure your expenses align with lender expectations.

Household Expenditure Measure explained: A key factor in assessing your home loan application.

What Is the Household Expenditure Measure (HEM)?

The Household Expenditure Measure (HEM) is a benchmark used by lenders to estimate your living expenses when assessing your loan application. Developed by the Melbourne Institute, HEM is based on data collected from household surveys, reflecting average living costs across different family sizes and income levels in Australia.

Rather than relying solely on your declared expenses, lenders compare your spending to the HEM benchmark to ensure your stated figures are realistic and to mitigate risk.

Why Do Lenders Use HEM?

Lenders are required by regulations, such as the National Consumer Credit Protection Act (NCCP), to ensure that borrowers can repay their loans without financial hardship. HEM helps them:

1. Standardize Expense Assessments: It provides a consistent way to measure expenses across all applications.

2. Identify Risk: If your declared expenses are significantly lower than HEM, lenders may question the accuracy of your financial disclosures.

3. Ensure Affordability: By incorporating HEM, lenders can estimate your capacity to manage loan repayments alongside everyday expenses.

How Does HEM Work?

HEM calculations consider various factors, including:

• Household Type: Whether you are single, a couple, or have dependents.

• Income Level: Higher-income households often have higher discretionary expenses.

• Living Standards: Basic, moderate, or lavish lifestyles impact spending habits.

• Geographic Location: Costs can vary significantly between urban and rural areas.

Lenders will typically cross-reference your declared expenses with the HEM benchmark. If your stated costs fall below the HEM figure, they may use HEM instead when calculating your borrowing capacity.

HEM Categories

The HEM benchmark groups expenses into the following categories:

1. Core Living Costs: Essential expenses such as food, utilities, transport, and insurance.

2. Discretionary Spending: Non-essential costs like dining out, entertainment, and holidays.

3. Debt Commitments: Credit card payments, personal loans, or buy-now-pay-later services.

How HEM Impacts Your Borrowing Capacity

HEM plays a significant role in determining how much you can borrow. If the lender calculates your expenses based on HEM and finds them high relative to your income, your borrowing capacity may be reduced.

Example Scenario:

• Your Declared Monthly Expenses: $2,000

• HEM Benchmark for Your Profile: $3,000

• Lender's Assessment: $3,000 (the higher figure used for calculations).

In this scenario, the lender will assume you spend $3,000 monthly, even if you claim lower expenses, which could impact your borrowing limit.

Tips to Align Your Expenses with HEM

1. Understand Your Financial Profile: Know your household type, income level, and typical spending patterns. Compare these to average HEM figures for households like yours.

2. Review and Adjust Spending Habits: Minimize unnecessary discretionary expenses, as these can inflate your assessed living costs.

3. Keep Accurate Records: Maintain detailed records of your expenses to provide clarity and evidence if required by the lender.

4. Pay Down Debt: Reducing credit card balances and personal loans can lower your monthly obligations and improve your borrowing capacity.

5. Consult a Mortgage Broker: An experienced broker can help you navigate HEM benchmarks and tailor your application to maximize your borrowing potential.

Common Misconceptions About HEM

1. My Declared Expenses Are Always Used: While you provide your expenses, lenders will default to the higher of your stated expenses or the HEM benchmark to ensure affordability.

2. HEM Is the Same for Everyone: HEM figures vary based on household size, income, and living standards. It is not a one-size-fits-all measure.

3. HEM Is Fixed: HEM benchmarks are updated periodically to reflect changing economic conditions and household spending patterns.

HEM and Responsible Lending

The use of HEM aligns with responsible lending practices. By considering realistic living costs, lenders ensure borrowers are not overextending themselves financially. This helps reduce the risk of financial hardship and ensures a sustainable loan repayment structure.

The Household Expenditure Measure (HEM) is a crucial tool in the mortgage approval process, helping lenders evaluate your borrowing capacity. While it may seem like a hurdle, understanding how HEM works can help you prepare your finances and increase your chances of loan approval.

At LNG Mortgage Solutions, we guide clients through the intricacies of the loan application process, including navigating HEM benchmarks. Contact us today to discuss how we can help you secure the right loan for your needs!