What is the Household Expenditure Measure?

What is the Household Expenditure Measure?

The HEM is a standard benchmark that some banks use to estimate people’s annual living expenses when considering home loan applications. HEM classifies more than 600 items in the Australian Bureau of Statistics’ Household Expenditure Survey as absolute basics, discretionary basics or non-basics:

• Absolute basics are most food items, kids clothing, utilities, transport costs and communications.
• Discretionary basics include take-away food, restaurants, alcohol and adult clothing and entertainment.
• Non-basics includes luxury services such as overseas holidays.

HEM is a net-of-housing costs measure, reflecting median spend on absolute basics plus the 25th percentile spend on discretionary basics. Rents and mortgage payments are not included.

How is HEM used?

The Household Expenditure Measure (HEM) can be used by lenders to assess borrowing capacity and help determine if applicants can afford a home loan. Separately, the Henderson Poverty Index (HPI) can be used to calculate living expenses. But not all lenders use these methods and some lenders have developed their own methods.

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What types of living expenses are considered in a home loan application?

Some common living expenses you may need to provide an estimate of in a home loan application could include:

• childcare
• children and pets (childcare, sports, tuition, pet expenses)
• clothing and personal care
• communication (internet, phone bill)
• education
• entertainment and recreation
• groceries
• health and fitness
• insurance
• medical
• other regular outgoing expenses
• transport
• utilities.

Why are living expenses important in a home loan application?

Whenever a person applies for a home loan, lenders are required by law (under the National Consumer Credit Protection Act 2009 and related responsible lending regulations) to consider their living expenses, in order to provide a fuller picture of their financial situation and whether they’ll be able to pay back the loan. One way they can do this is through the use of the HEM, which is meant to be used as a benchmark figure only. Lenders are also expected to make inquiries of their own about a borrower’s current income and expenses.

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Why is HEM controversial?

The use of HEM as a benchmarking tool has been criticised because of concerns that people were being approved for loans they couldn’t afford to repay. This is because there can often be a difference between borrowers’ estimated and actual expenses. Hypothetically, borrowers could struggle to meet their repayments if approved for a home loan following their living expenses (including non-essential items) being underestimated.

Historically, the grilling of one of Australia’s largest banks at the The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, revealed how shortcuts were being made in loan approvals and that living expenses were being underestimated in some cases. ANZ was found to have defaulted to using HEM in 73% of cases, instead of doing a deep dive into borrowers’ expenses.

The Commission also found that HEM was more useful to assess border-line borrowers and that it did not show the full picture of a borrower’s income and debt. The final report handed down stopped short of pushing for the HEM to be scrapped altogether, after several lenders had already started to move away from it.

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