Expert Advice with Simon Buckingham 17/08/2018
There have been a lot of changes in the lending environment over the past 3 years, but one of the most recent - and something that's tripping-up investors and home buyers right now - is a change in how banks assess your living expenses.
Now, be warned... What we're about to discuss may make you a little angry - as there's a distinct lack of common sense at work here.
But bear with me, because once we've worked through the changes (and had a bit of a rant along the way to make ourselves feel better), I'll explain what you can do about it - and how you can use the new rules as a positive opportunity to become an even better property investor!
What has changed...
Over the last year, the regulator of Australia's big banks - APRA - has been putting pressure on lenders to improve their "responsible lending" standards, including how the banks calculate how much a person can "afford" to borrow based on their living expenses.
On top of this, we've had the Financial Services Royal Commission, which has cast a poor light on some of the past behaviour of the big banks.
The response of the big banks to the pressure from APRA and the fallout from the Royal Commission has been to require even more supporting documentation for loan applications and to increase their scrutiny of living expenses and existing debts.
This increased scrutiny on a borrower's living expenses by the big banks means more paperwork and delays in processing loan applications thanks to a lot more manual handling.
So much paperwork!
Some of the big banks have taken this to the extreme in recent times. For instance, Westpac now requires loan applicants to provide a specific, itemised and evidenced break-down of their living expenses across 12 categories, including:
- Clothing and personal care;
- Medical and health;
- Telephone, internet, pay TV and other subscriptions;
- Recreation and entertainment;
- Owner-occupied property utilities, rates and related costs;
- Investment property utilities, rates and related costs; and
- "Other" (a vague category designed to capture anything else you might happen to spend money on that they haven't thought of!)
On top of having to provide all this detail on the application form, a bank may also ask you to provide your last 3 months’ worth of bank statements and credit card statements.
They'll then almost forensically examine the transactions on your statements and cross-check back against what you declared on the application.
Watch out if you forgot to include something that shows up on your statements! You can expect to be issued with a "please explain...", requiring you to detail what the cost is, whether it's a regular cost, and why wasn't it included in your declaration of your living expenses.
Ahhh, what joy!
But seriously... "what" joy???
How can any bank in its right mind think that this sort of prolonged, manual and cumbersome process is going to deliver a good customer experience?
But there's a more fundamental issue with the approach...
What does "discretionary" mean...?
In their crusade for more "responsible" lending, our regulators and lenders seem to have lost sight of a basic concept: the meaning of "discretionary"!
Many lenders now factor your discretionary spending (i.e. things you could easily give up, like a Netflix subscription) against how much you can borrow.
Anyone with real-world experience in owning property knows that you can and will sacrifice discretionary spending items in your budget in order to more easily afford the repayments on a home loan.
Magazine subscriptions, gym memberships, Foxtel, Netflix, and even takeaways and dining out are all costs that can eliminated from a person's budget at a moment's notice.
(Just like they can be added to a person's budget at a moment's notice if the person feels they can afford them.)
So why should they have any relevance to the assessment of your loan application?
And yet some lenders - particularly the big banks - now appear to treat discretionary spending as if it's some kind of fixed expense that you can't easily stop.
For example, there have been recent published examples where loan applicants have been told by their bank to give up their gym membership if they want to be approved for a loan.
Under this kind of model, even regular charitable donations may be counted against your borrowing ability... How wrong is that?!?
Suffice to say that you're now being treated by many lenders as if you're a financial moron who can't manage their personal finances - That you're somehow incapable of making sacrifices when needed to manage your personal finances.
Keep in mind that under current financial regulations you're already tested on your ability to afford a home loan at an interest rate of 7% or higher (almost DOUBLE current interest rates).
Add discretionary spending into the mix and count it against your borrowing capacity - on top of the higher servicing test - is just overkill!
If interest rates actually did rise to an average of 7% or higher (and we're a LONG way from that happening for the foreseeable future), the first thing to go from an investor's or home owner's budget would be those discretionary spending items.
The banks and the regulators need to give the average Australian some credit (no pun intended!) that they can manage their budget and make sacrifices when necessary to offset rising interest costs - as many home buyers have done in the past.
To be fair, the big banks are currently running scared because they've been mauled by the Financial Services Royal Commission for past misdeeds and mistreatment of some customers.
But in reacting to the political fallout by becoming overly conservative in the assessment living expenses (and losing sight of the meaning of "discretionary" spending) the banks actually fail customers -- by treating them as financial idiots, rather than being genuinely "responsible" and treating their customers with respect!
How SHOULD lenders assess living expenses?
Given the buffers in place in loan servicing assessments that already assume a borrower is paying much more for their loan than they actually are, I'd argue that a more common-sense approach would be to clearly differentiate "fixed" versus "discretionary" living expenses when evaluating how much a home buyer or investor can reasonably afford to borrow.
"Fixed" expenses would include rent or home ownership costs (mortgage repayments, rates, home & contents insurance, utilities, etc.), school fees, child care, ongoing medical costs, health & life insurance, and a reasonable allowance for essentials like groceries, transport, phone and clothing.
"Discretionary" expenses would include things like online subscriptions, gym memberships, "well-being" therapies (like naturopathy or chiro), dining out, charitable donations, or anything else that could easily be given up by the individual.
Truly discretionary expenses should have no bearing whatsoever on the assessment of an individual's ability to "afford" a loan of a certain amount.
What to do about it all...
We don't make the rules, and it might take a little time for sanity to be restored.
So, in the meantime, if your bank is going to treat you like an idiot who can't manage their money, then for the moment you'll need to treat them the same way...
If they can't appreciate that you're capable of altering your discretionary spending, then demonstrate your ability by making a few sacrifices now - in advance of your next finance application.
'B' is for 'Back to Basics' ...and for 'Budget'!
It's time to get back to basics, with some essential budgeting discipline...
Work out what you can sacrifice or reduce in your budget to:
(a) Make getting a loan easier; and
(b) Improve your financial position by keeping more of the money that you earn!
Make sure you stop spending on discretionary items like subscriptions, gym memberships, takeaways, etc. at least 3 months ahead of applying for a loan so that they no longer appear on your bank statements or credit card statements.
And remember that you can always re-subscribe to Netflix or your gym after you get the loan, if you can afford it and really want to.
Be aware that different lenders take different approaches to assessing expenses when calculating how much you may be able to borrow from them.
It seems to be the big banks in particular that are taking the most extreme approach to assessing living expenses.
Smaller lenders and non-bank lenders may not be as pedantic, so don't be afraid of exploring your borrowing options.
Vote with your feet if your existing bank has unreasonable policies!
Use these changes to become a BETTER investor!
The more disciplined you are with your personal finances,
the better you'll be as an investor.
the better you'll be as an investor.
The best investors have strong personal financial discipline - which is reflected in the discipline they apply to their investing - and ultimately their success.
So think of the recent changes in finance not as a negative, but as a positive reason to work on your financial discipline - which ultimately benefits your investing anyway!
If you aspire to escape the 'rat race', remember too that financial freedom comes from having more investment income than living expenses.
Making a few small sacrifices to lower your living expenses won't just make it easier to get more lending and help you keep more of the money that you make... it also reduces the level of expenses you need to cover from investment income to become financially independent
Look at each thing that you're currently spending money on, and ask yourself:
"What's more important... Spending money on this "thing" that I don't really need right now...or achieving my financial freedom sooner?"
Until next time,
P.S. - For more market insights and practical strategies, tips and techniques for investing successfully in today's changing property market make sure you come along to one of our upcoming free in-depth workshops and briefing sessions for property investors.
Simon Buckingham is Director of Results Mentoring and a highly experienced investor. Simon has been investing in property for over 15 years using a broad range of strategies including positive cash flow, renovations, property development and commercial properties, both within Australia and overseas.
Holding university degrees in Commerce and Law, and with over 10 years' experience as a business consultant, Simon turned his back on corporate life forever following the births of his two children and now spends his time investing, developing property, supporting multiple charities, and building businesses - while teaching others how they can do the same. He has personally coached hundreds of investors in techniques that can be used to profit from property in any market conditions, regularly facilitates public workshops and provides other free resources for property investors through ResultsMentoring.com, and has presented to thousands of people at property conferences and seminars around Australia and New Zealand.
Simon writes the highly regarded Sophisticated Property Investor e-newsletter and his opinions on the property market and real-world investing strategies have featured in Your Investment Property magazine, Smart Property Investment, Channel7 News at 6, Kevin Turner's Real Estate Talk, and Property Observer. He is co-author of the critically acclaimed property book The Real Deal: Property Invest Your Way to Financial Freedom, and a founding Mentor in Australia's award-winning personal mentoring service for property investors: the RESULTS Mentoring Program.
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.