Do you have a vision of your dream home? Maybe you are ready to buy it now.
You may be thinking your deposit (savings and equity) and regular income will allow you to successfully obtain a great home loan to buy your dream home. Not quite. Your living expenses also play an important part in determining how much you can borrow − or if you can truly afford one at all!
The fate of your loan application could rest on two things
- The Household Expenditure Measure (HEM)
The HEM is a measurement tool used by lenders to approximate your living expenses. This tool helps to determine your available income to repay a home loan. HEM is a figure that represents the average amount households spend each year. There are different HEM categories and lenders will match you to a corresponding HEM category. - Your living expenses
While in your application you ‘declare’ your living expenses, lenders also consider your actual living expenses recorded in your bank accounts’ daily transactions and credit card statements to verify your living expenses.
Importantly when assessing your loan, lenders will generally use the higher of your HEM category and your actual living expenses when determining your ability to repay a loan. Therefore it’s important to be conscious of your actual spending habits.
These determined living expenses will be deducted from your income to determine how much money you might have left over to repay a home loan.
The difference between the HEM and your declared living expenses is that the HEM is based on generic factors such as your location, the number of children you have, your married status and your lifestyle. Your lifestyle is based on an annual spending figure − not your income and tax bracket! There are four lifestyle categories: student, basic, moderate and lavish. Which one are you?
Why did you miss the boat on a great mortgage deal?
You may not have made an effort to clean up your spending habits prior to making a home loan application. This practice needs to occur for a reasonable period in advance.
How to prepare your finances for the HEM scrutiny
There may not be much you could do to increase your income in the short term but you could tidy up your expenses and finances in some of the following ways.
- Pay down your debts – The fewer debts you have, the more borrowing capacity you are likely to have.
- Cut back on your discretionary spending – Reducing your spend on entertainment, eating out or take-away food may help you fall into the ‘moderate’ or ‘basic’ HEM category.
- Improve your credit score – It’s important to pay your bills on time. Get a copy of your credit report and check it for any inaccuracies in loan applications or payment defaults. If there are inaccuracies seek to have these removed or resolved.
If you are in the market to buy your dream home and not sure where to start, we can help. We can guide you through ways to clean up your finances and the application process to put the most favourable case forward to your lender.