How the Royal Commission May Impact Your Borrowing Power
We have seen some significant changes over the past few months in the policies relating to home loan lending, which is having a big impact on how much investors can borrow. The most significant change is related to how lenders are calculating applicants living expenses.
Until now, lenders have used a system called the Household Expenditure Matrix (HEM) to estimate applicant living expenses. HEM is an average figure of monthly expenses determined by the median spend on absolute basics such as food, utilities, transport, communications, kids’ clothing, plus some discretionary basics, such as alcohol, eating out and childcare. Unless indicated in the application, this median amount has been used for all applicants, no matter how expensive an applicant’s lifestyle.
Each lender calculates their HEM values differently, but on average, HEM expenses are estimated at approximately $1,650-$1,800 per month, per person. This figure relates to the primary applicant; then there is a lower figure added in for a partner, and lower figures again for each dependent child.
Since the Royal Commission, lenders and brokers are now required to ascertain a full breakdown of exact monthly living expenses as part of the application process. When interviewing an applicant, I now include a detailed expenses breakdown so that applicants can provide what they believe reflects their monthly expenditure. Some of the information I ask for is:
- Estimated amounts spent on groceries
- A breakdown of recreation and entertainment expenses
- Costs involved with the operation and servicing of motor vehicles
- Education expenses
- Expenses related to owner-occupied bills
As part of the application process, brokers are also required to obtain three months of salary statements to confirm income credits and also to verify that there are no undisclosed liabilities. Some of the commitments I’m noticing are not being included or are being underestimated by applicants include interest-free credit cards, insurances and education expenses relating to dependent children.
A Case Study
I recently completed a pre-approval for a new investment purchase for one of my clients before the changes were introduced. At the time, the application serviced comfortably. After a few months, the applicant came back advising that he had made an offer subject to finance, which had been accepted. Given the pre-approval had expired, we had to reapply under the new requirements, with the addition of the salary account statements.
After reviewing the statements, I found a Mercedes Benz finance repayment of $1,523 per month as well as a GO MasterCard payment which had not been disclosed. I also noticed a payment of $8,000 which was paid to a prestigious school In Melbourne’s inner east. In the initial fact find, the client had listed only $300 in education expenses.
I questioned the applicant about these expenses, and sure enough, the education expenses were $32,000 per annum. I also learned there was a $75,000 car loan being repaid and an interest-free credit card for furniture with a limit of $10,000.
Once I took these additional expenses into servicing, the applicant’s ability to borrow had reduced to almost zero, and he had to walk away from the purchase. He could not afford to proceed based on what his actual expenses reflected, even though he told me he would have no problem making the future payments.
This is the perfect example of people living beyond their means and in my opinion, the reason why the royal commission has stepped in and made some significant changes to prevent people from experiencing future financial hardship. I know that there are a lot of brokers and applicants who don’t like, nor agree with the changes because they are finding it harder to gain finance approval for their clients. However, in my opinion, the tighter restrictions will likely be a good thing long term.
My Top 3 Tips For Property Investors
Here are three recommendations if you’re hoping to get a loan to buy an investment property:
1. Stop going into debt for stuff you don’t need.
Working in finance for the past 16 years, I have seen many changes, but the past few years have been the most significant with property prices exploding and people financing everything from motor vehicle purchase to overseas holidays. People are just unable to wait for anything anymore. It’s rare that you see people save these days and instead, turn to using the equity in their home because it’s easy and it provides that ability to buy stuff quickly.
2. Know where your money is going.
The expectation from others to “keep up with Jones’s” is at an all-time high. People are eating out a lot more and the price that we pay for things like food these days is way beyond what it was ten years ago.
They say that Melbourne has the best coffee in the world, but we indeed pay for it! My partner and I sat down to look at our expenses, and between the two of us, we had two large lattes a day from the local coffee shop at a cost of $5 per cup. Multiply that by 365 days, and that equates to $7,300 per annum!
Just to put things into perspective, a $200,000 Interest only home loan on the average interest rate is approx. $9,000 per year!
We are now the proud owners of a coffee machine and spend about $40 per month on coffee. It’s these little things that add up and make the difference between being able to buy a property or save for the next family car. It pays to sit down and have a look at where your money is going.
3. Differentiate between ‘wants’ and ‘needs’.
If you are unsure about the changes currently taking place and how they may affect you, we can discuss what you can do to help your financial position going forward and how making a few simple tweaks to your lifestyle, will improve your chances of pursuing your financial goals faster. Giving up some of life’s ‘wants’ rather than ‘needs’ and differentiating between the two, can make the world of difference.
Summing Up…
Summing things up, the royal commission changes are and will continue to affect lending overall, and unfortunately, it’s not going to be favoured by many people. There is a reason for the changes, and it’s for the benefit of you, the consumer, to ensure you aren’t left in a position of financial hardship and potentially lose everything you have worked hard to build.
Need Some Help?
Would you like to put my experience and finance network to work to see whether your interest rate and / or finance deal is the best possible in today’s competitive loan market – at no cost and without obligation? Just head to PropertyInvestingFinance.com, complete and submit the online form, and I’ll be in touch with you as soon as possible.
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Love your article Chris – especially the coffee. My hubby and I have always had what we call “mad money”. It’s our allowance or payment to ourselves and for almost 18 years, wasn’t much more than the max allowance $75/mth we gave to the kids. Only in the last 2 years have we increased it to $250 / month each. But the main thing is, I looked at my $5 Alm flat white even just 2x a week and that was still costing me $40 -$50 a week just on the coffee. Now, I might have 1 a week if at all. Instead I’m saving it for the “get-away” or helping someone in need.
This is a brilliant article. Very informative about the royal commission changes. To me it indicates a desperate cry out to all people to truly understand their own Cash flow. Love your work Chris. Great stuff
I aslo find your article very useful. Thanks for writing.
Great article mate, I’ve always been a saver and very much distinguished between the needs and wants, huge part of striving towards financial success, what you make is important but what you save is even more so!!!! When it comes to purchases etc for most people there is a cheaper option I would say.
Well written Mate, keep it coming.
Great article Chris. Well worth the read with some some excellent advice.
Chris…. were you thinking of the children when you wrote this article??.. (the children of coffee shop owners)
…. keep spending people, the service industry (and the Australian economy) grinds to a halt if you don’t keep spending… Because we don’t manufacture anything in this country anymore! ;)