How living expenses could impact your home loan application.
When applying for a home loan, lenders in Australia will evaluate and will want to see your total income and expenses under the National Consumer Credit Protection Act 2009, to assess and make allowances for your ability to repay the loan. This will include various living expenses that are listed in this article and the banks will use this information to determine your debt-to-income ratio, which is a key indicator of your creditworthiness.
Having high living expenses can make it more difficult for you to repay the loan and can raise red flags for lenders about your ability to manage finances. This can lead to loan rejection or approval with higher interest rates. Additionally, lenders will typically verify your income and expenses, and if they find that your spending more than you earn, it can decrease the credit score and affect the loan application. Therefore, it's important to budget and manage your living expenses effectively to increase your chances of being approved for a home loan and having a good credit score.
The different types of living expenses that could impact your home loan application.
To paint a more accurate picture of your financial situation when applying for a home loan, it's a good idea to take into account the different type of living expenses and include them in your budget. These expenses can include but are not limited to:
Credit card debt: Credit card balances and the associated interest rates can have a significant impact on a borrower's debt-to-income ratio. High credit card balances can indicate to lenders that a borrower is living beyond their means and may struggle to repay a home loan.
Car loans: Car loans, like credit card debt, can also impact a borrower's debt-to-income ratio. Lenders will consider the monthly car loan payments when evaluating a borrower's ability to repay a home loan.
Other outstanding debts: Other types of outstanding debts, such as personal loans, student loans, and other installment loans can also affect a borrower's debt-to-income ratio and credit score.
Living expenses: The cost of day-to-day living, such as rent, utilities, groceries, and transportation can also impact a home loan application. Lenders will consider these expenses when evaluating a borrower's ability to repay a loan.
Childcare: The cost of childcare can be a significant expense for many families should be factored into the budget as lenders will consider these costs.
Insurance: Lenders will also consider the cost of insurances such as health, life, car, home and other insurances
Transportation expenses: This includes the cost of owning and maintaining a vehicle, as well as the cost of public transportation, parking, and fuel.
What should your living expenses be?.
There is no one-size-fits-all answer to what your living expenses should be, as they can vary greatly depending on factors such as your location, lifestyle, and income.
Some guidelines you could potentially use depending on your individual situation includes the 50/30/20 rule, which suggests that you should allocate 50% of your income towards necessities (e.g. housing, food, transportation), 30% towards discretionary spending (e.g. entertainment, shopping, dining out), and 20% towards savings or paying down debt. However, it’s important to note that this rule may not be realistic for everyone.
Another guideline is the housing expense ratio, which is the percentage of your income that you spend on housing costs (e.g. mortgage or rent payments, insurance, repairs, and maintenance). Many financial experts recommend that this ratio should be no more than 30% of your income. Again, it’s important to note that this may not be an option for some and it’s important to consider what method is right for you depending on your individual circumstances.
Additionally, it's helpful to set a visual budget to consider what are your necessary expenses from your overall income. .
How lenders evaluate living expenses.
When assessing a home loan application, Australian lenders will typically examine your income, credit history and other financial obligations such as the living expenses themselves. Here is a quick overview in which lenders will evaluate your living expenses:
- Australian lenders calculate a modest level of weekly household expenditure for various types of families using the Household Expenditure Measure (HEM) method as a benchmark. HEM is calculated as median spending on absolute basics plus 25% spending on discretionary basics, while non-basics are excluded. The HEM is made up of several different elements including:
Location – People living in cities like Melbourne or Sydney usually have higher expenses than those living in rural areas
Household size – whether you are single, married, or have children
The number of dependents – the more children you have, the more expensive your living expenses will be
Lifestyle expenses – categorised as absolute necessities, discretionary necessities, and non-basic luxuries
- Self-assessment: Lenders will usually ask you to self-asses your living expenses in your home loan application. It’s a good idea to have a budget in place so you know exactly what your expenses for each month are, this will help you with filling out this section in your loan application.
- Bank Statements: Lenders will ask for at least 3 months of bank statements, from savings, credit card and other loan accounts, or use open banking to view your spending habits.
Impact of living expenses on credit score
It’s important to note that your living expenses can have an impact on a credit score - which has a direct impact on you when applying for a home loan. High living expenses can impact your credit score in several ways:
- Credit utilization: When you have high living expenses, it can be difficult to keep your credit utilization (i.e. the amount of credit you're using compared to your credit limit) low. A high credit utilization ratio can negatively impact your credit score.
- Payment history: High living expenses can make it more difficult to make your monthly credit card and loan payments on time. Late or missed payments can have a negative impact on your credit score.
- Debt-to-income ratio: Lenders use your debt-to-income ratio (DTI) to determine your ability to repay a loan. A high DTI can indicate that you're overextending yourself financially and may struggle to make loan payments, which can negatively impact your credit score.
- Recent credit applications: applying for multiple credit cards or loans can also have an impact on your credit score as it may indicate financial stress.
Strategies for Managing Living Expenses.
Regardless of your income and your expenses, managing you living expenses can be a challenge. However, with with the right approach, it is possible.to keep your living expenses under control. Here are a few tips
- Create a budget: One of the most effective ways to manage your living expenses is to create a budget. A budget will help you track your income and expenses and identify areas where you can cut back. Once you have a budget, you can make a plan to reduce your expenses and increase your savings.
- Prioritize expenses: Not all expenses are created equal, so it's important to prioritize your expenses. Necessities, such as housing, food, and transportation, should be your top priority. Discretionary expenses, such as entertainment and dining out, can be cut back if necessary.
- Reduce debt: High levels of debt can make it difficult to manage your living expenses. Consider ways to reduce your debt, such as consolidating your credit card balances or negotiating a payment plan with your creditors.
- Increase your income: One of the best ways to manage your living expenses is to look at ways to potentially increase your income. This can be done by reviewing your current salary and considering whether you should ask for a pay rise, looking at obtaining a higher-paying job, taking on a part-time job, or starting a side business. Please note, this method may not be a realistic option for everyone.
- Look for discounts and deals: Look for discounts and deals on the things you buy on a regular basis. This can be done by using coupons, shopping at sales, or buying in bulk.
- Cut unnecessary expenses: Review your expenses and cut out any unnecessary expenses. For example, you can consider canceling memberships or subscriptions that you don't use, you can also review your expenses from your bank statements.
- Automate savings: Automate your savings to go into a separate account that you can’t touch. This will help you build up your savings without having to think about it.
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*The information contained in this article is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, Joust recommends that you consider whether it is appropriate for your circumstances. Joust recommends that you seek independent legal, financial and taxation advice before acting on any information in this article.