For more than a decade, one magic number has made the difference between nabbing your dream home — or being rejected for a loan.
That number is the Household Expenditure Measure (HEM), a tool that has long been used by most of our banks to calculate our expenses and ability to manage repayments, which then helps determine how much we can borrow.
But it’s also hugely controversial — mostly because it’s a conservative benchmark, which means there’s often a big gap between a person’s estimated and actual expenses.
Since the banking royal commission has been underway, banks have started to reduce their reliance on the HEM amid fears Commissioner Kenneth Hayne would call for it to be banned altogether.
But that hasn’t happened.
In a surprise move, the damning final report stopped short of pushing for it to be scrapped, based on our lenders having already started moving away from it.
Analysts had worried that a push to abolish the HEM could make it harder for everyday Aussies to get home loans, which in turn could make our housing downturn worse.
WHAT IS THE HEM?
The Household Expenditure Measure is a tool used by lenders to decide whether customers can afford to pay off a loan.
It is calculated based on an applicant’s family size, location and regular lifestyle — including the median spend on basics like food, transport and utilities as well as “discretionary” items like alcohol and takeaway — and is the same method used by the Australian Bureau of Statistics.
WHY IS THE HEM CONTROVERSIAL?
It has been criticised for seriously underestimating people’s living expenses, which can potentially leave borrowers struggling to meet their repayments.
That’s especially problematic given just how widespread the benchmark is — in 2017, investment banking giant UBS estimated up to 80 per cent of all Australian home loans were approved using the HEM.
It has been under the spotlight for years, with bank regulator the Australian Prudential Regulation Authority (APRA) first questioning banks’ reliance on HEM in 2016.
In November 2017, APRA chairman Wayne Byres also publicly questioned its accuracy.
“We would like to see the industry devote more effort to the collection of realistic living expense estimates from borrowers,” he said at the time.
WHAT ITS SURVIVAL MEANS FOR YOU
Commissioner Hayne’s final report noted issues with the HEM but did not rule out its use altogether.
“While the HEM can have some utility when assessing serviceability (of a loan) — that is to say, in assessing whether a particular consumer is likely to experience substantial hardship as a result of meeting their obligation to repay a line of credit — the measure should not and cannot be used as a substitute for inquiries or verification,” the report stated.
According to CoreLogic research analyst Cameron Kusher, that means the ability to get your hands on a loan isn’t likely to get harder — for now.
“There were no additional recommendations that borrower credit assessment should be tightened further, and perhaps surprisingly, the HEM hasn’t been ruled out as a valid benchmark for assessing borrower expenses, implying credit availability is not likely to worsen any further,” he told realestate.com.au.
Angus Woods, the founder of independent financial adviser ratings site Adviser Ratings, said the HEM made sense when it was originally developed, but new technology had made it increasingly obsolete.
“The HEM was originally concocted because … banks didn’t actually have access to the level of data they have now on an individual, so they had to do it on an aggregate level,” he told news.com.au.
“It was first introduced 10, 15 years ago and part of the reason why it hasn’t moved is one, the inertia within banks, two, legacy systems, and three, just the speed in processing applications.
“Those sorts of principles are very hard for banks to move away from so the HEM became such an ingrained way of doing things.”
However, Mr Woods said there were now more accurate ways of tracking an individual’s spending.
“Now, technology is playing a greater role and banks have far more sophisticated access to bank accounts and how much we’re spending each month on food, groceries, entertainment — that can be tracked in a cohesive way, with real-time data now available on an individual,” he said.
But he said the move away from the HEM could end up having a “double whammy effect” on the property market, as it could slow down the approval process, potentially worsening the existing housing downturn.
“There’s the potential for it to have a knock-on effect to credit in general — in the short term over the next year or two, there could be an impact while the transition (away from the HEM) is underway,” he said.
He said slower loan approvals could impact people trying to access mortgages, which could have a flow-on effect.
He said individuals who wanted the application to go as smoothly as possible should consider tracking their own spending with apps or other tools to then provide to their lender.