Mortgage brokers have been a growing presence in the Australian lending landscape over the past decade or so.
In fact, 59.1 per cent of residential home loans are currently facilitated by a broker, according to data from researcher CoreLogic.
The service they offer is often highly valued by their clients, but broker remuneration came under fire in the financial services royal commission, with the result being a recommendation that major changes be made to the way broker commissions are paid.
While there are lobbying efforts and political conversations underway, we take a look at how broker payments currently work, what concerns the current model raises and what’s likely to change in the future.
The beginnings of mortgage broking
To understand why mortgage brokers are paid the way they are, we need to look back to the sector’s beginnings.
“Brokers originally entered the mortgage market representing smaller lenders who didn’t have the same means to reach the consumers as the big banks,” explains Brendan Dixon, finance broker and director of Pure Finance.
However, Dixon says as the big banks also began to move into the mortgage broking space, the broker’s role became to break down options for borrowers and facilitate a suitable mortgage for them.
A recent survey by research house Momentum Intelligence suggests that Australian borrowers appreciate this, with 95 per cent of the surveyed borrowers indicating they wouldn’t hesitate to use a broker again.
Unless they had to pay for it, that is.
Who pays the mortgage broker?
Mortgage broking is usually free to the consumer, no matter how small or large the mortgage.
Instead, the entire cost of the broker’s services is paid by the lender.
They do this in two main ways. First, with an upfront fee and then via a trailing commission that keeps getting paid for the duration of the loan.
95% of the surveyed borrowers indicated they wouldn’t hesitate to use a broker again…Unless they had to pay for it.
According to corporate watchdog ASIC, broker commissions are broadly similar across the lending industry, although there are some small differences.
But UNSW associate professor of finance Mark Humphery-Jenner says lenders have also been known to offer brokers ‘soft dollar commissions’ such as overseas conferences, vouchers or tickets to sporting events, none of which help concerns around conflicts of interest.
“Hypothetically, soft dollar compensation for increased loan origination could encourage excessive loyalty,” he explains.
“This is partially mitigated by the fact that borrowers compete with each other, causing homogenisation of soft dollar incentives.”
“Further, other commercial realities might limit the impact of soft dollar incentives, including the desire for brokers to secure repeat business.”
But more on that later.
How does the upfront fee work?
Once the mortgage settles, the broker is paid an upfront fee, typically ranging from 0.45 to 0.65 per cent. If the borrower later decides to refinance and increase their loan, the mortgage broker usually doesn’t receive further payment.
In its findings, the financial services royal commission recommended transferring this fee to the consumer, thus removing any potential conflict of interest.
The commission’s rationale was that this would clearly put the broker in the service of the borrower.
The hope is that this will achieve more transparency and less conflict of interest in the mortgage broking process.
How does trail commission work?
The other part of brokers’ payment is perhaps more controversial.
On top of the upfront fee, mortgage brokers also get paid a percentage (between 0.14 per cent annually according to ASIC) of the net loan balance for the life of the loan.
“This was introduced as a way to remunerate mortgage brokers for their ongoing advice, reviews and service once the loan has settled,” explains Dixon.
“Speaking from personal experience, trail commission provides a stable ongoing revenue stream needed to cover operating costs, staff wages, quiet months, and more.”
“I think the outcome of this will be a heightened appreciation for the mortgage broking industry”
“It also forms part of the asset value of a mortgage broking business.”
The trail commission also benefits the lender, explains Humphery-Jenner.
“It means that the lender can pay the commission over time rather than all up front,” he says. “They also work as an incentive for brokers not to switch borrowers from one lender to another.”
But that could all be about to change. In light of the royal commission recommendations, the federal Labor opposition says it will ban trailing commissions by July 2020 – a policy the current Coalition government initially supported before changing its tune on 12 March.
The fee-for-service model
The royal commission’s recommendation is to transition to a fee-for-service model.
To date, this has not been popular in Australia, while internationally, there is only one real economy we can draw learnings from.
The Netherlands introduced the customer-paid model in 2008 and began phasing out broker commissions from lenders. They were completely banned by 2013.
A recent report into the state of Dutch banks showed that this had a negative impact on market competition. From 99 banks in 2007, the Netherlands had only 44 banks in 2017.
The Australian government is aware of this and understandably cautious about potentially causing the same thing to happen here.
So it has asked competition watchdog Australian Competition and Consumer Commission (ACCC) and the Council of Financial Regulators to compile a report on the effects of banning trailing commissions on both consumers and market competition.
How will change look?
There is no doubt that change is coming to the way broking payments work, as early as next year.
Brokers don’t necessarily disagree with the royal commission’s recommendation to reduce conflicted remuneration models. However, they don’t all agree with how this is to be achieved – particularly when it comes to the ban on trails.
Still, Dixon is optimistic about future shifts and confident that brokers are equipped to absorb the change and remodel their business.
“I think the outcome of this will be a heightened appreciation for the mortgage broking industry off the back of all that noise,” Dixon concludes.
Let’s just hope the Australian consumer also reaps the benefits of any upcoming changes.
Watch mortgage industry veteran Mark Bouris discussing the latest on mortgage broker remuneration reform on Your Money Live in the video above.