Adding up the cost of mortgage brokers

One phone call saved my workmate $210 a month, but who is paying the cost of mortgage brokers?

The current system encourages mortgage brokers to encourage customers to borrow larger amounts.

Imagine going to McDonald’s and being charged $8 for a Big Mac, time and time again, only to find that your colleague was getting the same meal for $5.85.

That’s what happens in the mortgage market all the time, which is a lot bigger than that for burgers.

My colleague Scott Murdoch, after my prodding, rang his bank yesterday to seek a reduction in his home loan rate. He’d heard it was possible to obtain a mortgage rate in the “threes”. After a 15-minute discussion, Westpac promptly cut both of his two modestly sized mortgages by a cumulative 1.31 percentage points, saving him more than $210 a month.

Maybe you should try getting on the blower.

The penultimate week of hearings at the royal commission has put mortgages back into focus. And if you think mortgage pricing is sticky and opaque, consider putting mortgage broking commissions in the mix.

Commonwealth Bank chief executive Matt Comyn said about 1300 brokers earned more than $1 million a year.

It turns out about 55 per cent of new home loans, including my own last year, are issued via brokers, according to corporate regulator ASIC’s 2017 investigation into mortgage broker pay.

That shouldn’t be a surprise: using a broker is less hassle. Negotiating the blizzard of “products” with varying bells and whistles, which all embody the same underlying service, credit, would take hours. Plus the service is free at point of sale, even if some nominal sum would flow from the lender to the broker in the end.

In fact, that nominal sum is about half a percentage point of the value of the loan, and then every year after that the broker earns a further 0.14 percentage points in trailing commission, on average.

It looks like I had paid $8000 to my broker, reflected in a higher interest rate, and I’m barely 1½ years into my loan. Perhaps I should have waded through all the brochures myself. Actually, ASIC couldn’t find a difference in mortgage rates depending on how they were originated. So it’s not clear broker-originated loans do have higher interest rates.

Naturally, though, this cost must be embedded into everyone’s mortgage interest rates.

On a national mortgage pile of almost $1.8 trillion, even a small percentage point slice amounts to a motza.

If half the outstanding stock of mortgages were originated with brokers, and the 14-basis-point trailing commission holds, that’s $1.26 billion a year just in trailing commissions, a sum that royal commissioner Kenneth Hayne wryly suggested had a whiff of “fees for no service” about it.

Under testimony, Comyn suggested the current way brokers are paid should be reformed to make it more transparent. Understandably enough, the current system encourages brokers to encourage customers to borrow larger amounts. It also encourages borrowers to take out riskier interest-only loans, which allow them to borrow more.

No doubt many mortgage brokers add value, and many customers would be willing to pay for their services. Indeed, for a reasonable fee, I would still have used one. I’m not sure I’d have done so at a cost of $1500 a year for years on end, though.

Mortgage brokers help smaller lenders compete, too, providing the latter with ready-made distribution networks. And fewer mortgage brokers would mean more direct mortgage salesmen employed by lenders themselves. Employee or broker, the inherent cost of mortgage distribution won’t be going away.

Nevertheless, opacity of the ­remuneration structure, not to mention that of the underlying products themselves, is very likely to make those distributions costs much larger than they need be.

That’s before considering the risks of an embedded incentive for home buyers to borrow more for the economy.

For some bizarre reason mortgage broking was exempt from the 2012 Future of Financial Advice laws, a tranche of legislation that sought to stamp out conflicted ­remuneration and hidden trailing commissions in financial planning.

The Coalition in 2014 watered down the FoFA legislation to ­protect revenues streams in the ­finance sector, which coincidentally tends to support the Liberal Party. It removed the requirement for swathes of financial planners to ask their clients whether they wanted to keep paying fees that they probably didn’t know they were paying. Perhaps the ­Coalition wouldn’t be so bold now.

A flat, upfront fee structure ­between the borrower and mortgage broker would put downward pressure on the cost of mortgage broking.

It would be fairer, too: cross-subsidies flowing among borrowers that push up interest rates would be eroded — there’d be a lot fewer mortgage brokers earning more than $1m a year.

Comyn said Commonwealth Bank hadn’t moved to pay its brokers in this way for fear of being the first mover, and losing market share to the other major lenders.

Perhaps this will be something the royal commission recommends in its final report due early next year.