Analysts are telling us the banking royal commission has got off to a more "severe" start than expected. The focus? Irresponsible lending.

One of the ways banks could be forced to rein that practice in is by changing the way they assess would-be homebuyers for a loan.

UBS warned that for some applicants it could mean a reduction in borrowing capacity by up to 40 per cent.

We decided to take a closer look at what the possible change is and the scenarios people might find themselves in.

The change

There's this thing called House Expenditure Measure (HEM).

It's a benchmark banks use to estimate a loan applicant's annual expenses — a figure that becomes part of the calculation that determines borrowing capacity.

(UBS reported that in 2017, 70 — 80 per cent of all home loans in Australia used the HEM benchmark.)

The household expenditure estimate is based on a few things, including the state in which the borrower lives, the number of dependent children and their lifestyle across four categories:

Student

Student Basic

Basic Moderate

Moderate Lavish.

UBS says "in the vast majority of cases the 'basic' lifestyle assumption is used".

The basic lifestyle estimates annual expenses at $32,400.

UBS says that's unrealistic and families are likely to be spending a lot more and if banks are required to estimate expenses more accurately they could move to a lavish measure.

Let's look at the difference between a basic and a lavish scenario.

Remember, the income you have to service the loan doesn't change, just the expenses estimate the bank uses to determine how much you can get.

Scenario one: Under 'basic' measures

Income: $80,000.

Expenses under the basic measure: $32,400.

Based on the average of the four major bank's mortgage calculators, you could borrow up to $337,985 (or roughly 4.2 times your income).

Scenario two: Under 'lavish' measures

Income: $80,000.

Expenses under the lavish measure: $50,000.

The new borrowing capacity would be $195,912.

That's 2.4 times your income and a reduction of roughly 40 per cent in credit availability.



This is all to make lending more responsible

Banks have been moving toward a new model for evaluating the expenses part of the loan calculator for some time.

They've already established an Industry Working Group to design a new benchmark to comply with the Australian Prudential Regulation Authority's (APRA) "sound lending practices" guidelines.

It's unclear at this stage what that new benchmark might be. In the meantime, we look to analysts like UBS.

They reckon the banking royal commission's focus on HEM might mean restrictions will be brought in sooner rather than later.

And if that's the case, UBS said the lavish HEM benchmark could end up being much closer to what the royal commission might recommend.

What about other income brackets?

You can check out the before and after scenarios for other incomes below.

(Basic living expenses now increase with income, but UBS believe "this is only a recent adjustment" so they "have not taken this into account in this scenario".)

Gross income Basic living expense Basic borrowing limit Lavish living expenses Lavish borrowing limit $80,000 32,400 337,985 $50,000 $195,912 $100,000 32,400 484,315 $58,320 $327,000 $125,000 32,400 643,892 $68,320 $465,615 $150,000 32,400 817,340 $78,320 $538,622 $200,000 32,400 1,144,225 $88,320 $792,804 $500,000 32,400 3,141,171 $108,320 $2,472,763



