What is the Household Expenditure Measure?

Your living expenses play an important part in how big your home loan should be, or even if you can afford one. So what is the Household Expenditure Measure (HEM) and why does it matter if you’re applying for a home loan?

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. The Melbourne Institute explains:

• absolute basics are most food items, children’s clothing, utilities, transport costs and communications
• discretionary basics include take-away food, restaurants, confectionery, alcohol and tobacco, adult clothing, and entertainment
• non-basics include luxury services such as gardeners and 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, with the items used to work out modest expenditure for different types of household. Income, location, family size and type of lifestyle (student, basic, moderate or lavish) are factored in.

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 different 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 (among other factors),  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 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 banking royal commission revealed how shortcuts were being made in loan approvals and living expenses were being underestimated in some cases. As part of the Hayne Royal Commission, ANZ was found to have defaulted to using HEM in 73% of cases, instead of doing a deep dive into borrowers’ expenses.

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

In the separate ‘wagyu and shiraz’ case, the Australian Securities and Investment Commission (ASIC) famously lost a landmark case against Westpac, with the judge, Justice Nye Perram, saying “borrowers can forgo Wagyu beef and the finest Shiraz for more modest fare to meet loan repayments”. He found Westpac had not breached responsible lending laws by using HEM, instead of declared living costs, when assessing home loans.

Original author Ellie McLachlan.

Cover image source: By fizkes/Shutterstock.com