Finally going for brokers

Mortgage broking became a huge industry with no legal requirement for advisers to act in clients’ best interests.

Auctioneer Vic Lorusso in action at an Elanora Heights, NSW property. Picture: AAP

Applying for a home loan was a major event 40 years ago. Best clothes were donned and, at a pre-booked appointment with the manager of the local bank branch, reasons were proffered as to why the revered institution should deign to lend you money.

As often as not the applicant was sent away empty-handed, to recount the experience over barbecue­s with friends — most of whom had similar experiences with bank managers.

But in the early 1990s, following the relaxation of the banking syste­m, things began to change. In 1992, broking group Mortgage Choice opened its doors and ­“Aussie” John Symond set up shop, to soon start appearing on loungeroom TVs with some of the most rankling — but also among the most effective and memorable — ad campaigns.

Fast-forward more than three decades and the mortgage broking industry — which simply involves a broker or broker group ostensibly shopping around for you to find you the best deal on your home loan — has become a multi-billion-dollar behemoth.

Today more than half of home loans are “originated” by more than 16,000 mortgage brokers nationw­ide, as opposed to borrowers going directly to lenders.

Mortgage brokers performed a great service, by substantially increasin­g competition among the major banks, helping to drive down loan costs.

In March 2017, in large part due to the Commonwealth Bank opening its loan books, corporate watchdog the Australian Securities & Investments Commission found there were substantial differences, on average, between loans which had gone through a mortgage broker, compared with loans made directly by a bank, even though the same banks and other lenders were ultimate­ly lending the money.

Loans through mortgage broker­s were larger compared with the value of the property — deposits or other security was lower — and so were riskier, “even for customers with an (otherwise) identical estimate of risk”.

 

Brokers wrote more “interest only” loans, meaning each month the borrower is paying off only the loan’s interest and the full balance of the loan remains unchanged. Loans obtained through brokers had “higher incurred costs” — meaning customers were potentially paying more for loans than if they had gone directly to the bank.

Excesses in the industry, includin­g improper behaviour by some brokers, who can become fully qualified in just a few days, have been well known for years.

But following recent reviews by ASIC, the Australian Competition & Consumer Commission, the Productivity Commission, and Monday’s release of the royal commission into banking’s final report — which draws on the findings of all those agencies — the major change against which the industry has fought for years is a near certainty.

The extent of the changes to come will depend on the election battle of the next three months. Royal commissioner Kenneth Hayne has thrown the issue on the polit­ical pyre.

A detailed overhaul of the sector is one of the most substanti­al and proscriptive recom­mendations in the more than 1000 pages of his final report.

In the minds of most Aust­ralians, the role of mortgage brok­ers is straightforward. You need a home loan, you go to the local mortgage broker — no scrubbing-up necessary — and tell him or her you want a home mortgage.

Your financial position, income and so on are breezily noted and, in most cases, the broker provides you with a bunch of options with a range of banks and other non-bank providers.

You’re told it will need approval from the lender, and you’ll need to provide some documents, and you’re on your way.

You expect the broker is there to represent your interests, to get you the best loan and to steer you through the process.

The royal commission points out, as regulators have done earlier, that a borrower “rightly wants and expects the broker’s undivided loyalty”. A borrower who engages a mortgage broker wants “what the broker thinks will be best” for them. And if there is possibility a better deal can be struck with the bank, the borrower wants the broke­r to “strike the deal that is best” for them.

But as Hayne points out, after nearly three decades it is still unclear whether the broker is representing your interests, as opposed to the bank’s, and there is no set legal requirement for the broker to actually act in your “best interests”. “As has been noted … all too often advisers have preferred their own interests against the interests of their clients,” Hayne writes.

The payment structure for mortgage brokers provides a better­ understanding of how this might occur — why a broker might put the interests of the bank before yours.

 

Hayne says ASIC’s earlier review found mortgage brokers charged about $6600 per loan for their financial advice in helping to obtain a loan, almos­t three times the $2300 financ­ial advisers typically charge for providing a client with detailed “personal financial advice”, includin­g providing them with a written “statement of advice”.

At the size of the fee, and the discrepancy, Hayne doesn’t hold back. “No doubt the two tasks diffe­r,” he writes, in a tone with more than a little of his famed wry demeanour.

One, in the case of the financial adviser, involves “reducing the advic­e in writing”. The other, the case of the mortgage broker, involve­s “taking the information provided by the client and turn(ing) that into a loan applic­ation that the broker will submit”. “But the difference between the fees is striking,” Hayne writes.

“And it is all the more striking when it is recalled, as it must be, that home loans are not complic­ated financial products.”

In other words, there are an awful lot of people making an awful lot of money doing something that is not very hard.

Flipping though copies of industr­y publication The Adviser gives some indication of the riches on offer.

The publication’s November edition lists the “leading brokers in Australia”. Rankings, like almost all others in the sector, are determin­ed by the total size of home loans a broker has written.

In first place is Victorian Kevin Agent of the Australian Lending & Investment Centre, who wrote an eye-watering $171.2 million worth of residential mortgages over the prior 12 months.

Down the list the figures are similar: Queenslander James Hasselle of Mortgage Choice wrote $145.9m worth of home loans. But looking at the December 2015 list of the “top 30 under 30” ranking is perhaps more instructive.

Winner James Chatfield, 28, of Chatfield Consulting, wrote $149.7m of residential loans over the year, the publication says, for 329 home loans.

The Hayne report says mortgage brokers are typically paid commissions based on the size of the loan provided to the customer. The commissions are between 0.6 per cent and 0.7 per cent of the value of the home loan.

So for $171.2m in loans in a year, that’s $1.15m in commissions.

(The Australian is not suggesting those brokers have engaged in any wrongdoing.)

Which brings us to the questions most face when taking out a mortgage: who is paying for this broker? And as importantly, how much are they paid and how?

You are told the bank pays for the broker, which is part true — the bank does pay the broker. This is Hayne’s key concern. The mortgage broker is paid by the lender — so why would they not act in the interests of the bank and not the customer?

Indeed, the payments contribute to the “lenders being able to treat brokers as the lenders’ sales channel”, Hayne writes.

Observers also point out that the 0.6-0.7 per cent fee going to the broker has to come from somewhere, and with more than half all loans going through brokers that’s a very substantial amount of costs being added to the mortgage marke­t, costs ultimate­ly borne by almost all borrowers.

Brokers are typically paid via an upfront fee, of say $2000, as well as an upfront commission and a “trail commission”.

A trail commission is money paid to the mortgage broker who wrote your home loan over months and years for the entire time your loan is outstanding, often up to 30 years.

Hayne asks: “Why should a broker, whose work is complete when the loan is arranged, continu­e to benefit from the loan for years to come?” These trail commissions, he writes, “to put it bluntly are money for nothing”.

He points to the Productivity Commission’s findings on broking: “Trail commissions have the effect of aligning the broker’s interests with those of the lender, rather than those of the borrower.”

Hayne’s two main recommendations regarding mortgage broking are simple: make the customer pay for the broker, not the bank, so the customer’s interests are put first, not the banks’.

Secondly, ban trail commissions outright. Hayne says borrowers should pay for the broker, but borrowers should be allowed to add this bill to their mortgage, so they don’t need to pay it up front.

Brokers would be required to disclose these fees simply and in one place, which, Hayne says, would substantially increase competi­tion in the marketplace. The market would determine what the broker’s work was worth.

The biggest argument from the mortgage industry is that removing trail commissions and requiring borrowers to pay for advice would mean fewer people visited brokers, and so would not get ­advice as to the best lender, which would decrease competition and would increase interest rates.

Hayne says he is “constantly being told people want mortgage brokers”. If this is the case, why wouldn’t they pay a disclosed fee for it and have it transparently added to their mortgage?

Alan Kirkland, chief executive of consumer comparison group Choice, was one of many to hit back at the mortgage industry’s expected protests over Hayne’s proposals.

“It’s outrageously alarmist that this will lead to rate rises. There is absolutely no evidence in the repor­t that would support that claim,” he tells The Australian.

“There is a crazy contradiction in what the broking industry is saying — that customers tell them that mortgage broking is valuable to them, but on the other hand they don’t believe the customers would pay for it.”

Experts have predicted the number of practising mortgage brokers will drop by thousands in coming years, as and if the recommendations are implemented. However, Kirkland and others, includi­ng Hayne, say mortgage broking performs a valuable servic­e to many borrowers, and will no doubt remain, albeit as a diminished industry.

Hayne points to a likely emerg­ence of reliable mortgage compar­ison sites, such as those ranking and selling flights and hotel stays. Such a movement in the mortgage world is already well under way.

Mortgage broking is poised to be an election battleground. The changes to mortgage broking were the only Hayne recommendations Josh Frydenberg expressed reluct­ance to implement in full.

The government’s argument echoes that of the industry — that Hayne’s proposals would lead to reduced competition in the home loans market.

Experts say the government has exposed itself to an attack from Labor that it was again seeking to help the industry and mates in the big end of town.

“The pressure has been building on the mortgage broking industr­y for over 12 months with critical reports from ASIC, the PC, and the ACCC, and they have been very worried about what the royal commission would recommend,” Kirkland says. “What we see now with the government’s respons­e is a repeat of the same mistakes that ­Commissioner Hayne has said led to the royal commission in the first place.”