What is the Household Expenditure Measure?

The Household Expenditure Measure, or HEM, is a benchmark lenders may use when they determine whether an applicant will be able to make mortgage repayments on top of their other expenses.

But the measure is not without its critics. Let’s take a deep dive into how HEM is formulated, its controversial history as a lending tool, and how it may be used to assess home loan applications.

What is the Household Expenditure Measure?

The HEM is a standard tool used by many Australian lenders to help assess a household's basic living expenses and plays a role in determining an individual's borrowing capacity for home loans.

In simple terms, HEM classifies more than 600 items in the Australian Bureau of Statistics' household expenditure survey into three categories:

• Absolute basics
  Most food items, utilities, transport costs, communications, and children’s clothing

• Discretionary basics
  Take-away food, restaurants, confectionery, alcohol and tobacco, adult clothing, entertainment

• Non-basics
  Luxury services including gardeners, overseas holidays

It’s worth noting rent and mortgage payments are not included in HEM.

The HEM benchmark is then calculated based on the median spend on absolute basics plus the spend on discretionary basics by the bottom 25%.

How is HEM used?

Under consumer credit laws, lenders are legally obliged to take an applicant’s expenses into account when assessing their borrowing capacity. HEM is one tool used, though it’s likely not the only consideration of living expenses. Some lenders have developed their own measures that they may use in place of, or in conjunction with, HEM.

Some will look at a person’s average expenses over a certain time period. Others may ask would-be borrowers to provide estimates of their living expenses as part of their home loan applications.

Of the lenders that use HEM, applicants may be placed in a HEM category that also takes into account their declared and actual living expenses. In these cases, HEM may be used as a comparison tool or be adjusted for factors such as the applicant’s location, income, number of children, relationship status, and lifestyle standard.

Why is HEM controversial?

HEM was flagged as a controversial measuring tool at the Royal Commission into Banking in 2018 amid concerns lenders were approving home loans that borrowers couldn’t afford to pay back.

The main criticism was that HEM had the capacity to underestimate an applicant’s living costs if it was used as the sole measure of living expenses.

As well as regional variations, concerns were raised that using HEM alone could overlook applicants' unique circumstances, such as family sizes, employment situations, health conditions, and lifestyle choices.

The Royal Commission into Misconduct in the Banking, Superannuation, and Financial Services industry found some lenders were using HEM as a default shortcut and approving home loans where an applicant’s actual living expenses were considerably higher.

According to the Commission, ANZ was found to have used the HEM in 73% of cases instead of conducting a more thorough investigation of each applicant’s individual living expenses.

The Commission’s final report, handed down in 2019, stopped short of calling for the use of HEM to be scrapped. But, by this time, lenders were already moving away from using it as a sole measuring tool.

HEM in court

In 2019, the corporate watchdog ASIC took Westpac to court over the bank’s alleged overreliance on HEM in approving home loans from 2011 to 2015.

ASIC claimed the bank ignored customers' actual expenses when they came in higher than HEM estimates.

But Westpac fought the case, claiming it had factored in declared expenses to ensure they didn’t exceed 70% of an applicant’s income.

ASIC went on to lose the case, with Federal Court Justice Nye Perram ruling the law didn’t state explicitly the bank needed to use actual customer expenses, and essential living costs were more relevant in home loan applications.

In delivering his verdict, one of his remarks caught the public attention:

“I may eat wagyu beef every day washed down with the finest shiraz but if I really want my new home, I can make do on much more modest fare.”

Do home lenders still use HEM?

In more recent times, lenders may use the HEM as a starting point or in conjunction with other calculations.

Many lenders will commonly ask home loan applicants to provide an estimate of their living expenses, including:

• Groceries

• Utilities

• Transport

• Childcare

• Education

• Clothing and personal care

• Communications expenses (phone, internet)

• Medical, health, and fitness

• Insurance

• Entertainment and recreation

• Other regular outgoings, including repayments on other debts

They will then do their own assessment of applications. While being obliged to comply with responsible lending practices, lenders will also apply their own lending policies and guidelines in determining whether to approve a home loan application.