The Banking Royal Commission and Mortgage Brokers
The result of the Banking Royal Commission
The findings of the Banking Royal Commission, conducted by Commissioner Hayne, were made public on 4th February 2019. The report contains 76 recommendations, 5 of which are directly in relation to mortgage broking.
In particular, the Commission recommended that “trailing” commissions paid to Mortgage Brokers by Banks (and other lenders) should first be prohibited, and after 2 to 3 years all commissions should be prohibited (including Upfront commissions). Further it was recommended that commissions be replaced with “fees for service” paid by borrowers.
The Commission argued that the practice of commissions being paid by Banks and lenders to Mortgage Brokers creates a conflict of interest as brokers are incentivized to write as many loans as possible, rather than to act in the best interest of the Borrower. The Commission argued that a focus on volume leads to dishonest (“cowboy”) conduct.
Mortgage Brokers in Australia
The great majority of Mortgage Brokers are small businesses or contractors who earn all their income from commissions paid by lenders. A small number of Mortgage Brokers are owned by Banks or lenders – Aussie Home Loans was owned by the CBA for example. There are some 16,000 brokers in Australia who collectively employ over 27,000 people.
How commissions work for mortgage brokers
There are 2 types of commission paid by lenders to Mortgage Brokers – Upfront and Trail. Commission arrangements vary between lenders, and there may be individual arrangements (such as bonuses) with specific lenders or brokers however this is now very rare.
An Upfront commission is a one-time fee, paid a month after a loan is settled by the lender.
Upfront commissions are calculated taking into account various factors such as the loan amount and the net amount from funds in an offset account. Some lenders did once offer a volume based commission however those arrangements are no longer available, commission can be affected by the overall quality of loans submitted by the Mortgage Broker the commission paid can be affected by the level of arrears and defaults by the clients.
Upfront commission is usually in the range of 0.65% to 0.7% (+GST) multiplied by the loan amount.
For example, the Upfront commission on a home loan for $250,000 at a commission rate of 0.65% is $1,625.
Trail commission is a fee paid monthly for the life of the loan (once settled).
The Trail commission is usually in the range of 0.15% to 0.275% (+GST) per annum multiplied by the outstanding loan amount.
For example, the monthly Trail commission on a home loan for $250,000 at a commission rate of 0.15% per annum is $31.25 per month.
Factors affecting commissions
Several factors affect the ongoing payment of commissions;
- If a loan is fully repaid early (ie before the contracted loan term) the Trail commission is no longer paid.
In addition, if early repayment occurs within 12 months of settlement, the Upfront commission is “clawed back” by the lender (ie it is repaid by the broker to the lender), how much work the broker has done to get that customer the loan or despite the conduct of the lender to upset the client, the broker will get the commission clawback. This has been in the industry prior to the royal commission.
- If repayment occurs between 12 and 24 months, 50% of the Upfront commission is clawed back.
In some cases a further 25% may be clawed back in the third year.
- If a loan goes into arrears or default the Trail commission is no longer paid and the Upfront commission will be clawed back as described above.
- The Trail commission falls with the loan principal.
- As a resul of the Royal Commission, a net offset was included against the remuneration of broker commission. If a loan has been written and the client happens to put a lump sum in their offset account, the broker will only get paid on the net amount. If a client takes out a $200,000 loan and put $200,000 into their offset account, the broker wont get paid for the work they have done. The lenders are supposed to reverse this once the clients draws on the loan.
Also note that on average home loans are repaid or refinanced in 7 years, so the Trail commission on a loan will cease on average in 7 years.
Do borrowers pay any fees or commissions?
Generally Borrowers don’t pay any fees or commissions to Mortgage Brokers. In some instances however a fee may be charged, for example;
- Complex situations (which require additional time and effort)
- Small value loans, typically under $300,000 (where commissions are very low)
- Commercial or business loans (which require additional time and effort)
- Loans that repaid or refinanced within 2 years
Why are commissions paid to Mortgage Brokers?
Upfront commissions compensate Mortgage Brokers for the work required to establish a home loan by;
- Understanding and assessing the Borrower’s personal circumstances
- Reviewing the available alternatives – there are literally hundreds of home loans types and variations available from numerous lenders
- Preparing application documentation and collating supporting materials
- Answering lender questions and requests for further information
Trail commissions recognise that a Mortgage Broker will monitor the loan for its ongoing suitability and whether better alternatives may have arisen. Many brokers will conduct an annual financial health check at no cost to the borrower.
Mortgage Brokers also incur substantial indirect costs service such as administration and loan processing costs, licensing, compliance costs, professional insurance, ongoing education and office costs.
Are Mortgage Brokers conflicted?
There are many existing safeguards in place to protect Borrowers from inappropriate or unethical behavior.
Mortgage Brokers must hold an Australian Credit Licence (ACL) and adhere to the protections set out in the National Consumer Credit Protection Act 2001 (NCCP Act). In particular, a broker must not recommend a product that is unsuitable based on reasonable inquiries of the Borrower’s financial situation. In July 2020, a new legislation will be introduced which will require the mortgage broker to prove they have focused on what is best for their clients. Majority of mortgage brokers already practice this but this legislation will embed this into the finance framework and the ensure clients interest are above the broker and the lender. January 2021, the Best Interest Duty was introduced as further compliance.
Additionally, the structure of commissions is such that there is no incentive to promote unsustainable or unaffordable loans as both Upfront and Trail commissions are discontinued in the event of loan arrears or default.
What is the Best Interest Duty
The Best Interest Duty has been introduced for Brokers to act in their clients best interest. This is to ensure that the clients interest are priority over the Mortgage Brokers. Items that are assessed as Best Interest is the cost, Interset Rates, fees and charges and repayment size.
Cost is not the only consideration, there is non cost to be considered. The Mortgage Broker needs to make sure the loan features offer the consumer value and benefit.
Studies confirm that increase commissions do result in volumes
Studies by the Banks have demonstrated that increased commissions do not result in increased loan volumes. Rather the drivers of higher volumes are competitive interest rates, loan product features and borrower service.
Mortgage Brokers promote strong competition between lenders and provide a valuable, transparent service to borrowers – any lessening of that competition will likely have the effect of increasing loan rates and lessening services provided to borrowers – the opposite outcome to that intended by the banking Royal Commission.