Brokers who have a lend of you
George Liondis, Sun Herald, 19th of February 2006
Borrowers are less likely to get burnt if they know the types of commissions paid to brokers by banks and other lenders, George Liondis writes.
MOST people go to a mortgage broker because they want independent advice. After all, you can't trust the banks, can you?
What most people do not realise is the extent of the commissions that the banks and other lenders pay to brokers to recommend loans.
For the average-sized home loan in Australia of about $270,000, some lenders pay brokers more than $5000 up-front for every customer they bring in.
Others do not hand out as much upfront, but pay brokers a "trail" commission on the balance of the loan every year until it is paid off.
Borrowers don't foot the bill directly for commissions; lenders pay brokers out of their own pockets.
But if commissions influence brokers to sell a loan that is not the cheapest or most appropriate - something the mortgage industry calls "adverse steering" - then it will cost consumers in the long term.
A recent survey by banking analysts J.P. Morgan found that the size of upfront commissions was the single most important influence on the recommendations that brokers made to clients, while trail commissions were not far behind.
Finding a mortgage that was the best fit for a customer's needs wasn't even in the top five reasons why brokers recommended a loan.
The findings led one of the report's authors, Richard Wiles, to conclude that commissions were having a "disproportionate" impact on the mortgage industry.
In other words, commissions had a huge influence on which loans were recommended by brokers.
Going for broker
Consumers on the other hand seem largely oblivious to the role commissions pay.
The same survey by J.P. Morgan found that more than half of borrowers believed they were receiving "objective and independent advice from brokers", which goes some way to explaining the growing popularity of brokers.
The proportion of loans which originate through mortgage brokers is currently 35 per cent, up from about 20 per cent just three years ago. In terms of new loans, it is up to about 45 per cent.
And there could be room for more growth, if international experience is any guide. In the UK, 65 per cent of new loan borrowers use a mortgage broker. In the US, the figure is about 60 per cent.
The banks
Despite their huge branch network, all the big banks rely heavily on brokers to generate lending business for them.
St George Bank, for instance, sources 45 per cent of its new loan clients from brokers, while brokers account for about 35 per cent of new business at the Commonwealth Bank and about 32 per cent at Westpac.
Both National Australia Bank and ANZ get about 40 per cent of new business from brokers, although the ANZ's share fell from a high of 45 per cent early last year after it cut the rate of its trail commissions by 0.05 percentage points.
Typically, all the big banks pay brokers an upfront commission of between 0.55 per cent and 0.7 per cent, and a trail of 0.25 per cent.
That means every time brokers recommend a loan from one of the big banks, they are paid between $1485 and $1890 upfront, assuming a loan size of $270,000.
They also get 0.25 per cent on the balance of the loan every year. So, even 10 years from now when half the loan is paid off, the broker will still receive a pay cheque of about $340 from the bank.
Other lenders
When it comes to commissions however, the rates paid by the big banks pale when compared to non-bank lenders.
Without an extensive branch network, many of these lenders are entirely reliant on brokers to sell their mortgages.
One of the highest upfront commission rates is paid by Bluestone Mortgages - a "non-conforming" lender that specialises in finance to people whose credit history does not easily conform with the stricter requirements of mainstream lenders. At a commission rate of up to 2 per cent, a broker would receive $5400 upfront for recommending a Bluestone mortgage on a $270,000 loan.
However, unlike many of its competitors, Bluestone does not pay a trail commission on top of this rate. Also unlike many other lenders, Bluestone publicly discloses its commission rates - a move chief executive Alistair Jeffery says helps mitigate the "risk" of mortgage brokers mis-selling loans.
In terms of trail commissions, groups such as GE Money and Liberty Finance - both non-conforming lenders - pay some of the higher rates, offering 0.5 per cent and up to 1 per cent respectively. This is on top of an upfront commission of 1 per cent.
Evan Dwyer, managing director of broker solutions at GE Money, concedes that non-conforming lenders are more likely to pay higher rates of commission than mainstream lenders. But he says the payments are justified, because the types of clients - often including those with a tarnished credit history - who take up non-conforming loans require a greater degree of involvement from brokers before a loan is approved compared with mainstream clients.
"We pay more because it involves more work for brokers," Dwyer says.
Clawback
The bad news for mortgage brokers is that most analysts now expect the rate of commissions paid by lenders to be cut back, particularly by the banks.
Because of the slowdown in the housing market, the banks are having to discount interest rates to attract a smaller number of borrowers.
The feeling in the boardrooms of the major banks is that if they have to accept lower interest rate margins, then brokers should wear their fair share of the pain as well.
Many of the bigwigs in the banking industry are also spooked by the growing influence of mortgage brokers and resent having to pay them to sell their loans. ANZ and Commonwealth Bank have already cut commission rates and other lenders are expected to follow suit.
The banks are also placing a greater emphasis on enforcing "clawback" clauses. These allow them to force brokers to refund a commission payment if a borrower does not stick with a loan for the long term.
The idea is to stop situations where brokers recommend a loan that pays the highest commission, only for the client to switch out of the loan after a short period when they realise they have not got the best deal available.
Consumer groups are also pushing for greater regulation of the mortgage broking sector to put an end to what they call "predatory lending" (see separate story).
Shop around
The conflicts of interest that can arise when mortgage brokers are paid commissions to recommend loans are obvious. But that doesn't mean potential borrowers should necessarily avoid them altogether, says Garfield Wright, an analyst with mortgage research group Cannex.
After all, an honest mortgage broker acting in a borrower's best interest is a good one-stop shop for information about the wide range of loans that are available.
The trick, Wright says, is to go in with eyes wide open.
As long as borrowers understand the types of commissions brokers are paid, they are less likely to get burnt.
If mortgage brokers are not prepared to disclose the commissions they receive, then borrowers should walk away and find someone else.
It is also vital, Wright says, that borrowers do some shopping around of their own to see what sorts of deals are available in the mortgage market before they go to a broker.
That way, they will have a better idea if brokers have recommended the best mortgage, or whether they are just lining their own pockets.
