It seems like a no brainer.
The person you go to for independent financial and mortgage advice is independent and not aligned with a bank or financial institution.
The mortgage you are advised to apply for is best suited to your needs – and not because your broker is receiving a hefty commission from their preferred bank, or for suggesting you take out a larger loan.
But as the Royal Commission found, that hasn’t been the case.
In the final report from Commissioner Kenneth Hayne, released yesterday, the Commission placed a major question mark next to “conflicted remuneration” practices.
So what does it mean for mortgage applicants?
Mortgage brokers will be required to act in the best interests of borrowers and from 1 July 2020 “trail commissions” and other inappropriate forms of lender-paid commissions will be banned.
What does that mean?
Let’s break it down. A trail commission is the ongoing commission a mortgage broker receives from a lender after directing a loan their way. They receive this over the life of your loan and is paid to them on a monthly basis.
The idea behind trail commissions is that the mortgage broker will stay in touch with the borrower to check the loan is still suitable.
Treasurer Josh Frydenberg confirmed trail commission will be abolished, first for new loans from 1 July 2020.
“Why should a broker, whose work is complete when the loan is arranged, continue to benefit from the loan for years to come?” Hayne said in the report.
However the Royal Commission also recommended the industry shifts to a “user-pays” strategy.
Currently, brokers are paid by the lender they sign the customer up with. While it significantly reduces the cost to the customer, the conflicts of interest risks are easy to see.
Some lenders pay higher commission than others, and higher value loans also tend to attract higher commission payments.
Revelations that the Commonwealth Bank had removed the accreditation of 700 brokers who had not delivered a loan to the major bank in two years raised eyebrows at the Royal Commission, although the bank said the decision was not related to the broker’s delivery of loans.
Frydenberg said the government will commit to reviewing the up-front commission structure paid to brokers in three years. The removal of this structure would mean the cost of the broker’s service would shift to the consumer.
Okay, I see the problem. But…won’t this also make it more expensive for the consumer?
Brokers generally don’t charge the borrower for their service. But if lenders stop paying commission, that will change in a massive way.
In a note released this morning, ratings firm Moody’s warned the decision will serve to entrench the market dominance of the big four banks: Commonwealth Bank, NAB, ANZ and Westpac.
One of the benefits of mortgage brokers is that they generally open the doors to smaller lenders and promote competition in the lending sphere.
“The Commission notes that the benefits to competition from mortgage brokers, who promote mortgage products from smaller as well as the larger banks, have been diminishing over time,” Moody’s said.
“We expect this change will consolidate the market position and pricing power of the four major banks.”
The chairman of the Property Investment Professionals of Australia, Peter Koulizos agreed.
Cautioning against making blanket statements against professions, Koulizos said brokers promote “much-needed competition” and deserve to be paid for their service.
“We’re pleased that the Federal Government has questioned the recommendation that commissions be paid by consumers rather than banks – who are the ones who can clearly afford it the most.”
Unsurprisingly, the managing director of the peak mortgage broker body, the FBAA, Peter White is equally unimpressed.
Responding to the report last night, White slammed the touted move to a user-pays model and the agreed move to slash trail commission payments.
“This could force up-front commissions to rise in order to compensate for reduced revenues to brokerages, which in turn will lift interest rates and make housing affordability more difficult,” he said.
“If a user-pays model was implemented, we know that most borrowers wouldn’t pay, and banks would make more money and standards would drop further,” he continued.
Okay, next question: how much do brokers currently get paid by the banks?
Up-front commission is generally between 0.3 per cent and 0.7 per cent of the loan value. That means if you take out a $500,000 loan and your broker was receiving 0.5 per cent in commission, they’d make $2,500.
Trail commission is generally smaller, around 0.15 per cent.
If borrowers were to pay fees around $2,500, the services of a broker would begin to come with a cost usually associated with financial advisers.
“The mortgage broker industry is the one that is going to have the biggest challenge out of all of this in terms of no trail commissions and no volume bonuses,” Canstar group executive of financial services Steve Mickenbecker said.
Market research firm Momentum Intelligence last week released a report finding 96 per cent of consumers who used a mortgage broker were satisfied and 95.8 per cent would choose a mortgage broker.
Speaking at the time, the director of Momentum Intelligence, Alex Whitlock warned the consumer perspective on brokers had been missing during the remuneration debate.
“A serious implication of the proposed fee-for-service model is that consumers would be naturally driven to their primary personal bank, which is likely to be one of the big four. This would reduce competition by driving smaller lenders, who rely heavily on brokers, out of the market,” he said.
“Fewer lenders will give the dominant retail banks the opportunity to increase their margin by pushing up interest rates. With mortgage repayments and household debt concerns looming, this result could also potentially lead to higher financial distress for Australian consumers.”
Lifespan Financial Planning CEO, Eugene Ardino said that a major consequence will be that fewer people are able to afford advice.
“Up-front fees currently average $2,000 to $4,000. Advisers are prepared to initially service clients at a massive loss because of the possibility of an ongoing relationship with the client on a retainer basis,” he said.
“If you consider a reasonable hourly rate to be $250-$400, then the real price for this advice ranges from about $6,000-$14,000. If you reduce the certainty of the ongoing fee arrangements, advisers will need to ensure they cover much more of their costs from every hour spent with clients.”
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