This article was written by Noel Whittaker, the author of Making Money Made Simple and numerous other books on personal finance. noel@noelwhittaker.com.au. This article was published in The Herald on 14 February 2019.
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DECISION: Most mortgage holders want ongoing advice from time to time over the life of a loan – but how could a mortgage broker charge these people?
The Banking Royal Commission has certainly put a blowtorch to some dodgy practices in the banking sector, but that was hardly a revelation; many people, myself included, have been writing about them for years.
Higher “default interest” on loans in arrears and shonky insurance policies for credit cards are just two examples.
But what concerns me most is the proposal to ban trailing fees for mortgage brokers. While this has been welcomed in certain sectors, many people are ignorant of the purpose of trailing fees and how they work.
It’s a quirk of human nature that while most people have no problem with expenses that are deducted invisibly, they hate to receive a separate invoice.
Taxation is a classic case. Nobody seems to worry when they see $20,000 deducted in tax on their group certificate, but they will scream to high heaven if asked to actually hand over $500 to the tax office.
When the financial services industry was in its infancy, mortgage brokers’ main remuneration was by an upfront commission. The problem with this was that the business had no recurring income and was solely dependent on chasing new business to stay afloat.
The upfront-only fee was unsustainable, so eventually upfront commissions were slashed and a trailing fee introduced in lieu. This gave the business a basic income to rely on, enabling them to provide ongoing service to their clients without issuing a new invoice.
This is a different model to, say, a law office — who I am reliably told will charge $49 just to open an email.
I got some insight into the mortgage broking business last month, when I was researching borrowing for the family home.
The options were overwhelming; the criteria for loan eligibility were inconsistent and confusing; fees and loan rates varied from lender to lender and the choice of most suitable lender often turned on whether the borrower could meet certain eligibility criteria.
My conclusion was that it was far too hard to do it on my own – it’s best to get a mortgage broker.
My friendly mortgage broker tells me that on a $400,000 loan he would receive an upfront commission of 0.6 per cent – that’s $2400, paid for by the bank, but which can be “clawed back” from the borrower if the loan is paid out within three years of establishment.
The lender then pays the broker a trailing fee of 0.15 per cent, $600 per year, as compensation for providing advice to the borrower as needed. This could include advice about moving to a fixed rate, the situation if there was a change of employment, or what could happen to the loan if the borrower moved interstate.
The Banking Royal Commission has recommended that this system be scrapped. Applicants who wish to use a mortgage broker will have to pay an upfront fee – and if they can’t pay, it could be added to the loan.
Well, you know what’s going to happen. No young couple looking for a loan will be prepared to fork out over $2000 to a mortgage broker to research the market and find the best deal.
Instead, they will go online to look for what appears to be the best deal and jump in.
The banks will have a field day. Without a mortgage broker as an intermediary, borrowers will be at their mercy. Expect a return to loan establishment fees and even more complex products.
During the Royal Commission, the value of bank shares were slashed. But as soon as the market opened after the report was released bank shares were up around 5 per cent. I rest my case.
- Noel Whittaker