If you’re planning to use a mortgage broker any time soon, then you need to know something: Brokers are as much salespeople for the banks as they are advisers to you.
And that means they could very well not be acting in your best interest.
That was probably the most valuable lesson learnt in Thursday’s banking royal commission hearing, which involved a stern grilling of a senior manager at Commonwealth Bank.
Most Australians were probably vaguely aware that mortgage brokers were paid by banks. It’s obvious when you think about it – after all, they don’t charge customers a cent, so they must get their money from somewhere.
But the precise nature and structure of the payments made by banks to mortgage brokers is complicated and poorly communicated, which means your average mortgage customer is probably in the dark.
That’s a problem, because as the royal commission showed on Thursday, the structures of these payments encourages mortgage brokers to get you to borrow as much money from the bank as they can – even if you can’t really afford it.
That’s not to say they all do that. Many are no doubt behaving perfectly ethically. But the incentives undoubtedly encourage unscrupulous behaviour. CBA’s chief executive Ian Narev admitted as much himself. And the law doesn’t do all that much to protect the consumer.
How broker commissions work
Commissions are broken up into two categories: upfront commissions and trail commissions.
Upfront commissions first. Say you’re buying a house worth $500,000. You have saved $100,000, meaning you need to borrow an additional $400,000.
Your mortgage broker advises you to go with CBA for your home loan. It all looks fine to you – a decent rate, a well-known brand – so you go ahead. But what you may not realise is that, by putting you into that CBA loan, CBA rewarded your broker with a 0.65 per cent commission on the amount borrowed – in this case, $2600.
But here’s the really important bit: If you had bought a house worth $600,000, and therefore borrowed $500,000, your broker would have received $3250. That’s an extra $650 for no extra work. In other words, the mortgage broker has a clear financial incentive to get you to borrow more money.
But there’s more. So-called ‘trail commissions’ are an annual payment from the bank to your mortgage broker of around 0.2 per cent of the value of the loan.
For every year you are repaying your mortgage, your mortgage broker is receiving that 0.2 per cent commission. That means the broker has an incentive to make sure you are repaying your mortgage for as long as possible – i.e. borrow more money.
This doesn’t mean mortgage brokers are necessarily screwing you over. But the evidence suggests many are.
As the royal commission heard on Thursday, borrowers who arrange their mortgages through brokers rather than directly through banks are more likely to have a higher loan to value ratio (i.e. to borrow proportionally more against the value of the house), and are more likely to have interest-only loans (which take longer to pay back).
The law states that mortgage brokers must disclose if they are charging a commission. However they do not have to do this verbally, meaning it could be a diminutive clause in the application form – the sort of thing lots of us skim over.
Secondly, the broker has no legal obligation to disclose the structure and dollar amount of those commissions, not even in the fine print.
Here’s what the law tells mortgage brokers: “You do not have to disclose how the commissions, fees and charges are calculated, or provide specific figures, if you disclose how the consumer can request such information, and make it available on request.”
So you have a right to know, but unless you ask you probably won’t be told.
That doesn’t mean all brokers withhold the information. Otto Dargan, managing director of broking firm Home Loan Experts, told The New Daily his brokers do disclose the structure and dollar figure of commissions.
It is also worth remembering that, unlike financial advisers, mortgage brokers are not legally required to act in their customers’ best interest. As CHOICE explains in this useful piece, they are only obliged not to recommend an “unsuitable” loan, or one that will cause financial hardship – a much lower bar.