Childcare Costs in Loan Application: The HEM Calculator Reality

Introduction

When a mortgage applicant with young children submits a loan application, the lender’s assessment of living expenses plays a decisive role in serviceability. The Household Expenditure Measure (HEM) – a benchmark used by the majority of Australian lenders – often becomes the default expense figure. Yet HEM does not explicitly capture childcare costs. A family that pays $2,200 per month in childcare fees might find its borrowing capacity calculated as if that expense barely exists. The result is a serviceability figure that can be materially overstated, leaving the borrower with less room to absorb interest-rate increases or income shocks.

Arrivau examines the intersection of childcare costs and HEM‑based loan assessments, drawing on primary data from the Reserve Bank of Australia (RBA), the Australian Prudential Regulation Authority (APRA) and Treasury.

How lenders assess living expenses

Australian lenders estimate a borrower’s monthly living expenses through two paths: the applicant’s declared expenses or a benchmark floor. The dominant benchmark is the HEM, developed by the Melbourne Institute and adopted by lenders to comply with responsible‑lending obligations. APRA’s Prudential Practice Guide APG 223 Residential Mortgage Lending states that an ADI “should not rely solely on the applicant’s stated living expenses where those expenses are unusually low compared with benchmarks” APRA APG 223. HEM functions as that benchmark.

The HEM index stratifies households by income, location and family composition. For a couple with two dependants, the HEM figure might sit around $3,800–$4,200 per month, depending on income and metro/non‑metro classification. Lenders use the higher of the applicant’s declared expenses and the HEM floor. If an applicant declares expenses below the HEM value, the lender’s servicing calculator automatically substitutes the HEM amount.

Critically, the HEM index is not a line‑item budget. It aggregates a bundle of necessities – housing, transport, food, utilities, clothing, healthcare, recreation – derived from the Australian Bureau of Statistics’ Household Expenditure Survey (HES) but it does not separately identify childcare. The HES collects childcare expenditure as a distinct category, yet the Melbourne Institute’s HEM methodology collapses many sub‑categories into broader groups and does not release a child‑specific line. Moreover, the HEM series is updated infrequently; the most recent iteration still draws heavily on the 2015‑16 HES, which captured a period of different childcare costs and policy settings.

Because the HEM floor for a household with children is set at a level that reflects the average additional spending of all families with dependants – many of whom do not use formal childcare – the benchmark systematically understates the expenditure of those who rely on paid care. A lender’s automated servicing engine has no mechanism to distinguish a family that pays $0 in childcare from one that pays $2,500.

The childcare expense gap in HEM

Childcare costs in Australia are both high and unevenly distributed. RBA research shows that in 2019–20, the median weekly out‑of‑pocket childcare expense for families using formal care was $174 per child, rising to $244 per child for long day care RBA Bulletin, Sep 2020. A household with two children in full‑time long day care can easily face $500–$600 per week, equating to $2,200–$2,600 per month. That is a significant slice of after‑tax income.

When a lender’s servicing engine applies the HEM floor for a couple with two children, the figure might increase by only $500–$800 per month relative to a couple with no children. That increment is meant to cover all additional costs of raising children, including food, clothing, education, and childcare. In many families it falls well short of the true childcare bill alone. The RBA bulletin notes that out‑of‑pocket expenses vary markedly by household income, hours of care and eligibility for the Child Care Subsidy (CCS). The HEM does not adjust for these granular differences.

Furthermore, the prevalence of formal care means the shortfall affects a large share of borrowing households. According to the RBA bulletin, 48 per cent of children aged 0–4 attended formal care, with the highest usage among households where both parents work full‑time. For these families, childcare is not a discretionary expense but a precondition for earning the very income that is being assessed. Treating it as a submerged component of a general child‑related HEM increment obscures the real‑world cash‑flow impact.

The HEM calculator mechanics

Lenders’ online calculators and proprietary servicing tools treat childcare in one of three ways: as a separate line‑item entry that is added to the HEM floor, as a default assumed cost that replaces part of the HEM, or – most commonly – not captured at all beyond whatever the HEM figure implicitly includes. In the broker channel, which originates roughly 70 per cent of new mortgages, the application form typically asks for “total monthly living expenses” without a mandatory childcare sub‑field. A broker may enter a figure that reflects the applicant’s estimate, and the system will then apply the HEM floor. If the applicant has not separately stated childcare costs, the HEM floor becomes the sole expense anchor.

Consider a hypothetical couple earning $150,000 in combined gross income, with two children aged two and four in long day care. Their HEM for a major‑metro location might be $3,950 per month. If the couple declares total monthly living expenses of $3,600 (forgetting or minimising childcare), the lender substitutes the HEM floor of $3,950. The calculator then deducts that amount, plus a buffer for rate rises, from net income to determine surplus. Meanwhile, the family’s actual total expenses, including $2,400 in childcare, could be $6,000 per month. The servicing assessment overestimates the surplus by roughly $2,050 per month.

That $2,050 gap has a direct effect on maximum borrowing power. At an assessment rate of 6 per cent (approximate rate floor plus the 3‑percentage‑point serviceability buffer mandated by APRA), every $1,000 of surplus supports roughly $155,000 of principal‑and‑interest debt over a 30‑year term. The missing $2,050 surplus therefore implies an overstatement of borrowing capacity of more than $300,000 – enough to lift a family into a higher‑price bracket or higher LVR band.

APRA’s 2022 information paper on home lending practices acknowledged that “some ADIs’ use of the HEM benchmark may not adequately capture all material living costs” and highlighted opportunities for improvement APRA Information Paper. The paper did not mandate a specific childcare overlay but signalled that lenders should review the representativeness of their expense proxies. A few lenders have since piloted separate childcare expense fields that cannot be defaulted to zero; however, the practice remains far from uniform.

Regulatory and policy context

The National Consumer Credit Protection Act 2009 requires lenders to take reasonable steps to verify a borrower’s financial situation. The use of HEM as a floor is widely accepted as a compliance measure. ASIC has, in previous reviews, noted that HEM is not a complete substitute for expense verification but has not prohibited its use. Meanwhile, APRA’s prudential framework leaves the choice of expense benchmarks to lender judgment, provided the approach is prudent and periodically reviewed.

Government policy has attempted to reduce the net cost of childcare through the Child Care Subsidy. The Australian Treasury’s 2023‑24 Budget increased the maximum CCS rate to 90 per cent for families earning less than $530,000 and raised the subsidy taper Treasury Budget Overview 2023‑24. The change, effective July 2023, lowered out‑of‑pocket costs for many families. However, the relief is income‑tested. A household earning $200,000 receives a CCS rate of approximately 60 per cent, leaving residual weekly costs that can still exceed $200 per child. Gross fees have also continued to rise: the ACCC’s interim childcare inquiry noted that out‑of‑pocket costs for centre‑based day care increased by more than 20 per cent in nominal terms between 2018 and 2023, tempering the budget relief.

Lenders do not typically recalculate CCS‑adjusted childcare costs in real time. The servicing calculator relies on the declared expense figure, which a borrower may not accurately adjust for their post‑subsidy outlay. Thus, even families receiving substantial subsidies can be assessed on artificially low expenses if the childcare line item is omitted or understated.

What this means for loan applicants

A loan applicant who under‑declares childcare costs – whether inadvertently or because a broker enters a superficial figure – obtains a borrowing capacity that is higher than prudent. When the loan settles, the borrower must service the mortgage alongside actual childcare bills. The gap can immediately strain household cash flow.

The RBA’s financial stability analysis has repeatedly pointed to the risks of lending on unrealistic expense assumptions. In a rising‑rate environment, borrowers with minimal expense buffers are the first to encounter difficulty. An applicant who has been assessed with HEM‑only expenses and taken a loan at 95 per cent loan‑to‑value ratio has limited equity to fall back on. APRA’s serviceability buffer – currently 3 percentage points above the loan product rate – is designed to absorb rate increases, but its effectiveness depends on the accuracy of the expense baseline. If that baseline excludes $24,000 per annum in childcare costs, the buffer’s protective value is eroded.

Some lenders, particularly non‑bank and fintech lenders, have moved toward requiring a separate childcare expense field and will cross‑reference it with known childcare fee data or, at a minimum, refuse to process an application where the field is left blank. The major banks are exploring similar enhancements within their digital origination platforms, but broker‑introduced loans – where the interface often still defaults to a single living‑expense box – remain the dominant channel. Borrowers should be aware that the HEM floor is a compliance floor, not a comprehensive budget; if their true spending exceeds HEM, they should ensure the declared figure reflects reality. Lenders are entitled to decline a loan or impose conditions if posted expenses are inconsistent with income or lifestyle.

Conclusion

The HEM calculator’s treatment of childcare costs remains a significant shortcoming in Australian mortgage underwriting. While the HEM benchmark provides a regulatory‑compliant floor, it fails to capture the large, discrete expense that childcare represents for many families. RBA data confirm that out‑of‑pocket childcare costs can exceed $2,000 per month per child, yet the incremental HEM allowance for children often amounts to less than half that figure. APRA’s guidance encourages expense verification but does not mandate a childcare overlay, leaving a serviceability gap that borrowers ultimately bear.

The information in this article is general in nature and does not consider individual circumstances. It is not personal financial advice. Borrowers should consult a licensed mortgage broker or financial adviser before making loan decisions.