Fixing a Broker System
Mark Nathan – Managing Partner, Banking & Financials Analyst
Mathieu Blake – Associate
Fixing a Broker System – ASIC’s review of mortgage broking remuneration.
When it comes to buying a new house, more than half of Australians consult a mortgage broker. We use brokers for a number of reasons. Some need an expert hand to help them wade through the paperwork. Some harbour a deep distrust of banks, so seek out a trusted middle man. Most common however, is simply that we believe a broker will battle with the lenders to help us get the best rate possible.
Source: Mortgage Choice
However, according to a recent report published by ASIC, mortgage brokers may not be the heroes we hoped. The ASIC report investigates the remuneration structures for mortgage brokers, using years of home loan data, as well as its own independent studies.
From the pool of customers involved in this ASIC study, 86% believe that a mortgage broker has an obligation to find the best rate and act in their client’s best interest. However, under the current law, brokers and lenders are only required to ensure that a loan recommended to a customer is “not unsuitable”.
Home loans are exempt from Chapter 7 of The Corporations Act (2001), which outlines obligations for financial service professionals. This little regulatory gap means that mortgage brokers have no statutory obligation to act in your best interest and get you the best rate. Instead they are free to recommend loans which may be “fit for purpose”, but offer them better commissions.
There are generally four parties in a broker generated home loan. The borrower, the lender, the aggregator (a business which sits between brokers and lenders, providing administrative support) and the brokers. Mortgage brokers are usually not paid a salary, instead relying on commissions payed for by lenders, the largest of which are the big banks.
The big banks have ownership stakes in several large broking groups/aggregators. This is often raised to suggest a lack of independence. For example, CBA owns a controlling stake in aggregator Aussie Home loans. CBA has 20.9% of mortgage market share, yet Aussie directs 37.3% of loans to CBA. NAB’s mortgage share is 13.2%, yet NAB owned brokers direct 22% of business to them.
In practice, many remuneration structures for brokers are volume based, meaning they pay commission on the total loan amount approved. The ASIC report found that this commission structure incentivised brokers to write riskier loans, with higher loan-to-valuation (LVR) ratios. The more the broker can convince the customer to borrow, the more they pocket themselves.
Percentage of loans with an LVR of more than 80% (By Distribution Channel)
The myth that brokers can achieve better rates as compared to going directly to a lender, has also been refuted in this report.
Overall Impressions of Mortgage Brokers
A pattern of brokers recommending risky loans to at-risk borrowers was also noted by ASIC. According to the report, consumers who use brokers have lower incomes and are of a younger demographic than those who get financing through other avenues. Loans arranged by brokers were 25% more likely to go into arrears (30 days) than loans arranged directly through lenders.
Linked to this problem is ASIC’s finding that lenders and brokers did not make sufficient inquiries into their customers’ expenses. They identified significant numbers of loans across several lenders where the consumer expenses were conveniently stated to be equal to the Household Expenditure Measure (HEM). This means that brokers have taken a shortcut to get loans across the line.
Further, soft dollar benefits are rampant across the industry. Write enough big loans and brokers will be rewarded with free attendance at courses or conferences; competitions (e.g. trade promotions) under which entry is linked to the sales numbers; hospitality and entertainment rewards and broker clubs. These clubs are offered by some lenders and aggregators, and provide benefits like better service from lenders if brokers hit certain targets.
Lenders have (rightly) argued that providing better service to brokers is good for the customer. However, this does not stop brokers favouring the lenders who tempt them with rewards and forgoing a better loan for customers.
Soft dollar benefits come in all shapes and sizes. Although ASIC conceded they generally have less influence on loan recommendations than commissions, the lack of records and disclosure of benefits is a worrying factor. The highest disclosed soft dollar benefit in 2015 involved an all-expense paid for a trip for an aggregator’s top brokers, with a $13,000 per head cost (and a total cost of over $1 million).
ASIC’s report wrapped up with recommendations for changes to the broker remuneration system. First and foremost, ASIC recommends commissions be restructured so they are not dependant on the size of the loan. Volume based commissions are already being prohibited by the Future of Financial Advice (FOFA) reforms in industries like financial advice. It’s possible that mortgage brokers are next. They also recommend cracking down on soft dollar benefits, improving disclosure of aggregators’ ownership structures and better oversight by lenders and aggregators, on the conduct of brokers.
It could be a while before we start seeing tough regulatory changes, but the report sheds some light on a broken system. While there are plenty out there who do look after their clients and provide welcome support to home buyers, it may well be a situation of a few bad apples causing substantial change to the economics of mortgage broking businesses.
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