Since the release of the final report of the Financial Services Royal Commission led by the Honourable Kenneth Hayne AC QC, there has been much discussion about how mortgage brokers are remunerated for their services.
In this article we take a look at the issues and explain why the payment of mortgage brokers is such tricky subject.
Currently, mortgage brokers are paid in two (2) parts
- An upfront commission paid by the lender
- An ongoing trail commission paid by lenders for as long as the loan remains in place
The advantages of the current structure include
- No upfront cost to the borrower
- Trail commissions acting as a disincentive against brokers churning (re writing the loan each year or two (2) with a different lender just to earn more commissions
However, there have long been issues raised in relation to the conduct by some brokers including
- Bribery
- Forgery
- Fraud
- Fudging of figures
- Encouraging borrowers to borrow more than perhaps they should
- Placing loans with lenders who pay larger commissions
The crux of the issues involving the broking industry can essentially be boiled down to one (1) thing. It is all based on sales rather than client outcomes. The more loans a broker settles, and the greater the amount of each loan, the more they get paid.
The Royal Commission proposes lenders should be prohibited from paying any commissions to mortgage brokers with existing trail commissions being excepted. Instead, Commissioner Hayne says fees should be paid by the borrower to the broker.
Positives of the proposal
- Borrowers would know exactly what the broker is being paid
- Reports by the Productivity Commission, the corporate regulator and the competition regulator have noted the notion that brokers are good for competition has been discounted over time
Negatives of the proposal
- Borrowers may be less likely to use a broker knowing they have to pay for their services directly out of their own pocket
- If fees are folded into amounts borrowed, the real cost to the borrower could be substantially higher once interest is factored in over the term of the loan.
- Lenders may have greater power to dictate terms to borrowers if fewer borrowers have someone advocating for them in negotiations
A review conducted by ASIC in 2017 called Review of mortgage broker remuneration recommended on minor changes to existing upfront and trail commissions. The Treasury Department’s submission to this review suggested removing trail commissions would increase conflicts of interest rather than reduce them. In other word’s the Commissioner Hayne’s recommendation could make things worse.
There is significant time and paperwork for brokers in meeting with clients, gathering information, and compiling the information to provide to lenders. It takes significant skill to understand and interpret what a client is and isn’t telling you, to identify whether it may be possible to find a lender willing to lend to a given borrower, understand the different loan products offered by a multitude of lenders.
It could be argued the majority of borrowers who use a broker really don’t understand how much work is involved.
Commissioner Hayne also recommended mortgage brokers be subjected to a “best interests” duty which would require brokers to act in the best interests of their client similar to accountants, solicitors, doctors and more recently financial advisors among others.
The main problem with existing commission structures has always been trying to figure out a better remuneration plan to discourage these kinds of behaviours. While there is no doubt there are some mortgage brokers who’s actions are at times less than honourable, there are rogues in all industries across any job you care to name.
The debate will continue to rage as to the merits of existing practices and Commissioner Hayne’s recommendations but one has to wonder why a best interest duty does not already exist. It could be argued all sides of politics have let the Australian public down but not having already introduced a simple measure which could perhaps render the commission v upfront fee debate void.
The commission’s full report can be found here https://financialservices.royalcommission.gov.au/Pages/default.aspx
