Royal Commission - It's All About You As Well
Recently the Royal Commission report into Misconduct in banking and insurance has been handed down. The report highlighted several issues within the industry that need to be resolved. While the report contained 76 recommendations for our industry the most contentious recommendations were:
- Removal of trail commissions,
- Moving to a ‘user pays’ fee for service model,
- Introduction of a ‘best interest’ test.
Just so you, as a consumer, can understand the unintended consequences of these recommendations below is our summary of our concerns.
This is perhaps the most inaccurately reported item in the media. Several years ago brokers were only paid an upfront fee by the lender when they referred a client to them. It was the lenders that approached the industry with concerns that once paid a broker had no incentive to maintain an ongoing service to the client. To overcome this, they proposed that the fee be split into 2 payments – a smaller amount up front, and then a small regular monthly payment paid over the life of the loan – if the loan was paid out quickly the broker earned less money; but if the loan ran longer then they earned more.
Over time the deferred portion of the upfront fee became referred to as a ‘trail fee’. The reality is that it is a deferral of the historical upfront fee. Why is ‘trail’ important? It allows broking businesses to grow a recurring income source that allows us to invest in our businesses and plan for the future, it also allows us to deliver ongoing services to consumers (you) after the loan has settled – things like releasing guarantees, renegotiating loan terms, reviewing your loan to ensure that you are still getting the right deal. Even little things like changing payments from monthly to weekly, changing addresses – the things that we do every day that we do not ‘charge’ for.
There are two main arguments against trail fees. The first being that they are anti-competitive because they discourage refinances. This is incorrect – when we negotiated your loan initially it was a great deal, but over time your needs change, lenders change their loan terms, and what was great may not be now. If we refinance you with a new loan from your existing lender trail continues. If we refinance you to a new lender, well they pay us a fresh upfront and a trail as well. So, the fee is clearly not anti-competitive.
The second argument is that trail fees add to the cost of your loan. For those of us with a fair share of grey hair will remember in the late 1980’s the bank’s net interest margin – the difference between what they pay an investor and what they charge a borrower was up to 5%. In the early 1990’s the broking industry was born, bringing new lenders and competition. Today lender margins are around 2% - so effectively brokers and their trail fees are saving you 3% on your loan every day of the week.
If trail is the problem, why don’t the lenders charge people going directly to them less? The reason is simple – the lenders have reduced staff, closed branches, centralised services all to save costs. But let’s face it, having a lending manager in a branch costs money. Having the branch costs money. Brokers are a cheaper distribution channel than branches. So, the reality is, clients that use brokers should probably be charged less.
The proposal at present is to increase the upfront payments to compensate for the loss of trail. While this will not see remuneration altered drastically it sees the industry back to where it was 20 years ago, and this is not where even the majority of lenders wanted to go.
This is the really nasty recommendation, and now both major political parties have come out saying that this will not happen. But what if it had? Under user pays (or as it was referred to, the ‘Netherlands Model’) the consumer (you) would have had to pay brokers for using their services. The commissioner himself realised that people would be reluctant to pay a fee for a service that they were currently getting for free – so rather than forget the idea the suggestion was that lenders would also have to charge a fee that consumers (you) would have to pay – it would not matter if you went to the lender direct or a broker – this was a new fee that you had to pay.
This was truly anti-competitive. Your existing loan may not be the best loan for your current needs – but would you pay a fee somewhere between $2,000 and $5,000 to refinance? Suddenly refinances would become far too expensive, locking you into a poor loan. And the Commissioner speaks of “good consumer outcomes”.
The fee was also inequitable – the size of the loan made no difference as the fee was flat. This meant that higher income earners borrowing more paid proportionately less than a lower income earner borrowing less.
Introduction of a ‘best interest’ duty
We must admit that while we support this initiative it does somewhat confuse us. Good brokers already do this, that’s why you use us, that’s why you refer your family and friends to us. But let’s get back on point – how do we interpret ‘best interest’? Is it the cheapest loan, is it the loan with the particular feature that you want, is it the lender that can deliver a quick turnaround time, is it the lender that we know will give you a great banking experience. The devil will be in the detail when the legislation is presented, so maybe more on this later.
However, part of this best interest is the perception that brokers send you to the lender that pays them the most commission. We will admit that there may well be a small number of brokers that do this – but it is both stupid and short term. Why is this so?
The range from the lender that pays the most commission to the one that pays the least is nominal – about 0.1%. If lender A is charging 4.19% but paying a commission of 0.7% while lender B is charging 3.59% and paying point 0.6% commission where are we going to send you? Providing lender B matches your needs they will get your business every day – why? Because if we don’t deliver you a great deal you will refinance the loan we arranged (if this happens the lender takes back our upfront commission) and you won’t refer your family and friends to us. Meaning that over time we will write less loans, earn less, and eventually go out of business. Remember as well; we must disclose to you the commission that we earn. When we are presenting options feel free to ask about the different commissions that the lenders pay – we are actually happy to tell you and show you.
As has been proposed over the last week or so it is far easier to standardise lender commission structures, this eliminates this concern.
And now “why this is all about you as well”
These changes threaten the financial viability of brokers. Most brokers have average incomes of about $90,000 per annum before their expenses (cars, phones, offices and so on) and the proposals would see income reduce by up to 40%. This would reduce the number of brokers which would then flow onto less competition in the market. With reduced brokers many smaller lenders (who get up to 90% of their loans from brokers) will be curtailed and leave the market. With reduced competition comes higher pricing.
The Royal Commission was about misconduct in banking, many of the reforms to our industry would only benefit the banks with the largest branch networks.
A few statistics
- Nearly 60% of home loans are written by brokers,
- Satisfaction ratings for broker loans are far higher than bank direct loans,
- There are about 17,000 brokers in Australia supporting an additional 22,000 jobs,
- Most brokers are sole traders and small businesses, living in and supporting their local communities,
- In November there were over 6,000 complaints lodges with the Australian Financial Complaints Authority, less than 0.5% of these complaints were about brokers.
If you wish to discuss the points raised please feel free to Contact Us. If you wish to register your support for a review of these decisions please support us and our industry by signing this petition https://www.change.org/p/federal-treasurer-josh-frydenberg-save-the-mortgage-broking-industry