Does this sound familiar? Your client has completed their estimate of living expenses, broken down into the dozen or more areas that your Fact Find categorises, and the sum total comes in at $3,430 a month for a family of four.
Then, you pour over their last three months transaction statements, and the brutal truth is revealed – their average living expenses are looking a lot more like $6,500 a month – this changes EVERYTHING!
While the responsible lending provisions introduced with the National Credit Act had always required applicants to declare their living expenses, some verification efforts were to simply compare the client’s estimate against the Household Expenditure Measure (HEM). If the client’s estimate of living expenses were the same or above, everyone was happy! If the client’s estimate was below HEM, the lender would tend to deem HEM to be the minimum benchmark for servicing purposes.
In October 2018 that all changed when Commissioner Hayne released the Banking Royal Commission Interim Report, in which he concluded that using HEM as the default measure of household expenditure assumed, often wrongly, that households do not spend more on discretionary basics than allowed in HEM and the HEM takes no account of spending on ‘non-basics’.
So, in a climate in which brokers and their clients are facing increased scrutiny, there are two interrelated areas of focus – evaluating living expenses and guiding your client through the expenses assessment phase of their loan application journey.
“Brokers have no shortage of regulatory resources. The challenge is to get guidance on how to put it into practice and apply it to customer scenarios. That is where quality, industry-relevant learning and mentorship can make the difference,” says Financial Education Professionals CEO, Kate Whiteley.
Evaluating living expenses
A proper assessment of living expenses can be tricky and this can be a common cause of loan applications being rejected by lenders. Given that, it’s important to get it right the first time. Here are 5 living expenses assessment tips:
- Savings discrepancies – If a client says their living expenses are $1,000 and they are earning $4,000 in net income a month, then they should be saving $3,000 per month. It is a simple step to verify how much they are saving by checking their bank transaction statements. If they are not saving $3,000 then you need to find out where the money is being spent.
- Missing expenses – It’s easy for a client to overlook a regular expense like health insurance, school fees, gym membership or the costs of car registration and maintenance. These can be innocent mistakes, but the errors can have consequences and they can be time consuming to correct. Make sure you extract all the information you need during the interview process by approaching the questioning from different angles. Don't just ask them for a list of expenses, talk to them about their lifestyle and spending habits to get a broader idea of where they spend their cash if you can’t spot expenditures on the transaction statement. With additional insights, you can then start making more specific enquiries to help ensure you don't miss anything.
- Discounting rent payments/income – If your client is planning on living in the home they purchase, existing rent payments do not need to be included in the living expense assessment. Similarly, if your client is refinancing and their assets include an investment property they are now moving into, then they need to adjust off their income the rent they will no longer be receiving. Either way, be sure to check the situation carefully.
- 'Guesstimating' – Some clients simply have no idea what they spend and what they might need to spend in the future and it's part of your role to help them work it out. Use your experience and knowledge to help your clients fully understand their financial situation and be sure to make an accurate assessment. Don’t take a chance on a 'guesstimate'.
- Actions can have equal and opposite reactions – With the emergence of services like Uber Eats and Netflix, your clients may have recently incurred increases in grocery or entertainment costs – which, on the surface, may appear as a problem. But consider the inverse effect these expenses have in the grand scheme of your client's lifestyle and balance sheet. Is your client now spending less on groceries at the supermarket thanks to their increased use of Uber Eats? Or has your client now stopped regularly going to the cinema now that they have Netflix?
Discussing your client’s financial habits
In 2019, there is little appetite in using the HEM to verify a client’s living expenses. Indeed, many of Australia’s major lenders (both bank and non-bank) are insisting on being granted read-only access to transaction statements as verification, in many cases, via software that analyses and classifies income and expenses. So, how do you have that conversation with your clients?
We recommend putting yourself in your client’s shoes. It's human nature to underestimate spending and generally your client is not being intentionally deceptive when their personal financial awareness is out of step with the information you have on hand.
Use empathy and check to see that they understand exactly what you have asked of them. For example:
“You estimated that your living expenses were $3,430 a month yet having a quick glance through your last 3 months’ savings statements, I calculate it to be more like $6,500 a month on average. Perhaps you had some extraordinarily large one-off expenses during the quarter. Are you able to shed some light? Or should we review and increase that amount?”
“You mentioned you had no debts apart from your personal loan, yet I can see Afterpay deductions on your transaction account. Is that account still current or has it been paid in full? So many people simply don’t register that Afterpay is a financial commitment. I see it all the time and I do have to ask you to clarify.”
The more brutal reality of course is that, based on these higher, more realistic living expenses, your clients can likely no longer afford to borrow the loan amount originally requested.
How does that client conversation play out? What are their options? There are always options and you need to communicate them clearly, succinctly and empathetically:
- They may qualify with another lender, perhaps one with a lower assessment rate and/or a 35- or 40-year loan term.
- They may still qualify with their preferred lender, but at a lesser loan amount.
- They may qualify with their preferred lender at the desired loan amount, if they are prepared to reduce credit card limits and/or show evidence of having paid out smaller personal debts (such as 'buy now pay later' scheme purchases).
- They could sacrifice some of their discretionary spending, set a savings plan and stick to it for at least the next 3 months to prove they can live on less and thus provide 3 months’ transaction statement verification of this 'new normal' household living expenditure.
These life-changing conversations should ensure that you are better positioned to meet your compliance obligations while your clients achieve well-intentioned, evidence-backed and hopefully, desirable outcomes.
Authored by Therese O’Neill
Therese O’Neill, a professional mortgage industry adviser and mentor, is a member of FEP’s practitioner faculty and a regular industry news columnist.