Need to measure household expenditure accurately for lending purposes

From

Alfred Moller

In light of the Royal Commission there has been much scrutiny towards the banks and by mortgage brokers. One of the key findings within the Royal Commission is the lack of verification of customer living expenses from mortgage brokers and the acceptance by the banks.

The banks have always used a combination of the Household Expenditure Measure (HEM) and the Henderson Poverty Index to compare an applicant’s “Declared Expenses” to the “benchmark” average living expense. It is not hard to find an article or blog from a mortgage broker slamming the banks for increasing living expenses above what has been declared by the customer.

This seems unfair, right?

Let’s look more closely into the living expenses used by the banks and compare them to available consumer data.

HEM

The HEM considered by the banks will vary significantly depending on the household make up and the amount of income earned. From my experience, in 2017 the average declared expenses accepted by banks, not including housing were:

  • Single, no dependants – $1850 per month or $426.92 per week
  • De Facto, no dependants – $2,500 per month or $576.92 per week

This is interesting when compared to the Australian Bureau of Statistics (ABS) “Household Expenditure Survey, Australia: Summary of Results, 2015-16” report that outlined that both the basic household expenditure and discretionary spending has increased year on year since 1984. The average basic household expenditure was $846 per week in 2015-16 and is considered to be necessary spending such as housing, groceries, fuel, health care and transport. The average discretionary spending was $579 per week in 2015-16 and is considered to be any spending that is not necessary such as luxury and consumer goods.

The 2016-17 report has not yet been released, however the trend would suggest a continued increase in both basic and discretionary spending. Keep in mind that the ABS survey isn’t adjusted for inflation. This gives us a base understanding of consumer behaviour, noting there is a clear difference of $998.08 per week between the HEM and ABS for an individual with no dependants. Even if we consider the cost of accommodation for a one bedroom or studio apartment in Sydney of $550 per week, there is still an enormous difference of $448.08 per week which the banks would not have accounted for.

This leads to a fundamental issue which is currently being investigated by the Royal Commission.

The banks have since increased the HEM in a reactive rather than proactive way. Did the banks allow a sufficient allowance for “actual” spending in the current high cost of living, low growth environment?

Based on the above comparison, my opinion is no. Even with the stress tests and higher serviceability rates used by the banks, they have not adequately addressed the likelihood of increasing rates, cost of living, inflation and low income growth rates.

So who’s to blame?

I do feel that it is hard to point the finger at one person or entity.

Firstly, it is the banks’ responsibility to ensure the sustainability of their lending practices.

Secondly, mortgage brokers have a part to play in verifying expenses and ensuring that the loan is in the best interest of the applicant.

Finally, I believe an emphasis is required on the responsibility an applicant has in the lending process to reflect their true living expenses as opposed to underestimating them.

Mortgage brokers and banks can ask as many questions as possible, however there is always a margin for someone to lie.

An undisclosed default or expense can be detrimental by causing delays, at times resulting in a declined application and an unnecessary credit enquiry.

In this environment, brutal honesty is required by the applicant with a failure to do so impacting the entire lending process.

Although painful, the Royal Commission will shed further light into lending practices and provide a sustainable solution to the living expense crisis.

By Alfred Moller, Residential and Small Business Lending Specialist

You must be logged in to post or view comments.