Banking Royal Commission- What the changes could mean for you
One of the biggest shocks of the Royal commission is Kenneth Hayne suggesting you should be paying for your mortgage broker similar to the model used in the Netherlands – but will that be in the best interest of the consumer and competition ? We’ve had a look into how that system works and how it might impact competition and, most importantly, how it will impact you, the consumer.
The Dutch model essentially involves the consumer paying a fee for service. This is the case weather they approach a bank directly or through a Broker. In theory, as the banks are not paying mortgage brokers commissions, they would be able to charge a lower interest rate on your mortgage -great hey! The issue is that the Australian market differs quite a bit in that the majority of mortgages are variable not fixed for a long term, 5 or 10 years as the case is in the Netherlands. A variable rate means your bank has control over what rate you pay and banks have historically increased rates for existing customers while offering low rates to continue to entice new customers. Take CBA for example, our research on the current rate which our clients were paying at CBA before they engaged are services was 4.64%, where as a new customer can pay 3.85% for the same terms.
In 2011 regulations was introduced to abolish exit fees to make it easier for home borrowers to shop around for better deals - even if they already have a loan. At the time the Government said mortgage exit fees have been "one of the biggest roadblocks stopping Australians getting a better deal for their families''
Then Treasurer Wayne Swan produced the regulation, which became law, as part of a package to boost competition among lenders, particularly the major banks. This allowed borrowers to "walk down the road if their bank isn't doing the right thing by them''.
The Royal Commission recommendations effectively reverses this, by reintroducing a ‘fee for service’. This means if you want to move banks to get a better deal, it would likely costs upwards of $4,000 to do so. So when the bank starts to ‘nudge up’ your interest rate once you a customer, they have you trapped.
How did Mr Hayne come to this conclusion?
A study quoted by CBA noted that Broker loans were reliably associated with higher leverage, have a higher incidence of interest-only repayments, have higher debt-to-income levels, higher loan-to-value ratios and higher incurred interest costs compared with Branch introduced loans. Hayne suggest that this is directly a result of the current commission model and that ‘If there are other causes of the results, they are, at least, less obvious’.
I agree with Hayne, the reasons are less obvious, however a look a little deeper shows findings from Roy Morgan in 2018 state the majority of the broker market is made up on Millennials (48%) and generation X (38%) with Baby boomers making up just 9% of the market. It’s no surprise that First Home buyers and young investors entering the market are borrowing with a smaller deposit and taking longer to pay off their loans than their parents are who are nearing retirement and have approached the bank directly. We note the findings do not quote the rate of interest charged on the borrowings, only that the amount of interest was higher.
Trailing commissions result in a better consumer outcome
Under Hayne’s recommendation, your Accountant, Tennis coach or local Barista would be able to refer you to a bank and receive commissions- which are currently only slightly less that your mortgage broker would make in upfront commission. So long as they “do no more than refer the potential borrower to the lender and facilitate the borrower making contact with the lender’ – an interesting resolution to the problem of trying to achieve better consumer outcomes.
This also appears in contradiction to Hayne’s recommendations on trailing commission (where the bank pays an annual commission to the broker while ever the loan remains with their bank instead of the whole amount upfront) where he states ‘put it bluntly, is that they are money for nothing’ and not in the best interest of the consumer. The predominate reason that the lender has decided to pay this in the past was to prevent churning (refinancing to another lender). Further, trailing commission means the broker benefits when your loan stays under their banner, so it’s in their best interest to ensure you continue to be happy with the loan and it is well suited to your needs.
Generally this is done by doing annual reviews and renegotiating your rate with the current lender on your behalf- if they don’t come to the party they can provide you with the options of moving banks. Conversely, it’s in the banks and their shareholders best interest to be making the most money of your as possible, so you wont find them calling you up after a year to let you know they’re reducing your rate.
Impact on First Home buyers.
The proposed fee for service model could also mean a first home buyer would need to come up with additional funds to get into the market. There have been some suggestions that the bank will allow the customer to borrow these additional funds (thanks, more interest and a higher loan) however this would have implications on the fees the bank charged. The Bank’s currently charge lenders mortgage insurance for loans where exceed 80% of the property’s value, of which they typically receive a commission from the insurance company for arranging. Higher borrowing means higher fees for the customer and more commission for the bank. This was not addressed by Kenneth Hayne in his report. We suggest this is because its been a while since he has gone through the process as a first home buyer.
So who would this system benefit?
Would your broker give you better advice because you are paying him and not the bank? Unlikely-see your mortgage broker currently only gets paid when your loan is successfully settles. If you aren’t happy with your loan and refinance it within the first two years- the broker typically gets clawed back, so if you leave they lose some or all of their commission they received for arranging the loan for you.
Mortgage brokers are typically small companies with one of two employees, it is suggested by Hayne that they have perverse incentives to encourage you to maximise your loan in order to maximise their commissions. The reality is most brokers are offering you the best possible service and product, so that you refer them to your friends and family and come back when it’s time for your next purchase.
Its not clear whether mortgage brokers would survive with a fee for service model. However It is clear that the fee for service model is not suited to the Australian consumer lending environment, It will reverse the changes from 2011- making it more costly to change banks and will likely result in higher interest rates for consumers and more profits for the banks.