Opinion: David Lammey – Firstmac’s General Manager of Digital Brands.

Of the >$350-odd billion in home loans written each year, more than half of these are handled by a mortgage broker. And of these, more than 60-70% used products from one of the ‘big four’ banks. Brokers get paid an upfront commission on the value of the loan (typically around 0.65%) as well as an annual trailing commission on the loan balance from year two onwards (typically around 0.15%).

And whilst it is not the case with every home loan product purchased through a broker, it is generally acknowledged that a punter will pay a small premium on their interest rate when they go through a broker, compared to the relative rate they would have paid from the same product lender (eg. bank) by going to them ‘direct’.

To illustrate what this premium might look like, a 0.2% interest rate premium on a $350,000 loan would equate to around $700 per year in extra interest payments (decreasing in proportion with the loan as it is paid down), which is a lot!

So taking this into account, along with the fact that 55-60% of all new loans are written through brokers, it is stating the bleeding obvious that there’s a big need for mortgage brokers in the home lending landscape!

Why? Because getting a loan can be complex and require a lot of time and effort – and when many of the lenders themselves aren’t that great at it – it can also be a very convoluted and ‘bureaucratic’ process!

And lets face it, the big four banks have probably perfected convolution and bureaucracy in almost everything that they do.

However, in talking about how much brokers get paid (e.g. cited in many places this week at around $5-7k per loan) it is important to realise that their reward structure is 100% commission-based. That is, the banks only pay a mortgage broker IF and WHEN they bring a new loan (new purchase or refinanced loan) on board for them. No new customer and loan, no pay for the mortgage broker!

This makes mortgage broking a much riskier occupation than most,because if you don’t get your backside out of bed in the morning to get up and toil away at writing new home loans, you are 100% guaranteed NOT to earn any money that day!

So while $5-7k per loan sounds like a lot of money to pay someone, when you factor in the risk that mortgage brokers face in NOT getting paid, then I can appreciate the toil/risk/reward trade-off.

This begs another question to be asked, which is why don’t banks just create ‘in-house’ brokers and pay them an annual salary? The answer to this is not a simple one, but a I bet that a big chunk of it has to do with the flexibility of being able to ‘dial up’ and ‘dial down’ new loan sales volumes without having to wade through the HR minefield of putting on and putting off salaried staff.

And then there’s also the commercial benefit of being able to lock in an arrangement where they pay a fixed % based fee (of loan value) and only when that new loan is guaranteed to them. In other words, reducing their risk of paying money and not getting any new home loan sales in return for it.

Now lets talk about the other suggestion this week from the Hayne Royal Commission that the customer pay for the services of the mortgage broker (which apparently they do in the Netherlands).

I have to say that I was at first a bit confused about this concept, but before I could apply any rational thought to ‘why’ the customer should pay – I was bombarded with ‘sweeteners’ from advocates of the concept like “you’ll be able to simply add it to the amount of your loan” (as opposed to having to pay for it up front) and “quite clearly people are happy with the service – so they should be happy to pay for good service”.

What a load of rubbish. Lets come back and focus on the core premise.

Show me a business who can blatantly charge new customers for the cost of acquiring them. It is a ‘cost-of-sale’ as they say in the game, it is the cost of doing business! Does Hayne understand the basics of business micro-economics? This concept is nuts (and it is increasingly sounding a bit like a rort or some dodgy mind trick to me….).

Let me try and put this madness into an analogy that does it justice. Imagine you go to buy a new car. After all of the test drives, negotiating and general gnashing of teeth, you are ready to sign on the dotted line and buy the brand new (lets say $40,000) car. At this point, the sales person (who is paid on a commission-only basis) lets you know that you have to pay an additional $1,200 ‘service’ fee – and explains that it is to help cover the dealership’s costs of all of their TV, Outdoor, Online and Newspaper media for their advertising – as well for their advertising agency costs. Would you cop this? I wouldn’t.

Before mortgage brokers were around, banks’ cost-of-sale was a bit harder to work out, as they had to try and split out the proportion of all their big costs (it’s not cheap running big branch networks and paying the top brass all of those big bucks). Their people in the branches and at the coalface probably had a fair idea of these variable ‘costs-of-sale’, but no doubt the top brass paid many a management consultant to come in and tell them what they thought. And low-and-behold, they found out that it cost them a lot of money to bring a new home loan customer on board.

I’m not saying that this was the reason that the mortgage broker industry came about. This was due to a fundamental lack-of-competition in the market and a blatant opportunity to provide much better service than people were getting at the time from dealing with the above mentioned convoluted and bureaucratic rubbish that the big banks were throwing up.

But when they did enter the market, the big banks realised they could outsource a big chunk of their new home loan ‘chasing’ business and not only reduce their cost-of-sale ‘costs’, but also carry less overhead in their businesses (eg. having their own sales people on their books). I imagine there were probably a bunch of big bonuses paid to the top brass (as well as their management consultants) for this ‘strategic’ brain wave.

But I digress. The idea that a new home loan customer should pay for a popular and widely-used service like a mortgage broker (instead of the bank baring it as a cost-of-sale) is ridiculous – and made preposterous by the added context of their need being driven by the lack of ability and willingness of many lenders being able to bring new customers on themselves directly. Hopefully the current and future Government (whichever it ends up being) have the common sense to knock this idea on the head and consign it into the waste paper basket of ‘self-rated brilliant brain waves that never made it onto the main stage’.

For feedback or queries, email david.lammey@savings.com.au

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