If you use a mortgage broker, as one in two Australians buying a property does, then a new government-commissioned report has some uncomfortable news for you: you’re running the risk of being ripped off.
That’s not because mortgage brokers are crooks. There is no suggestion in the report that anyone is acting illegally.
Rather, it’s because the laws as they currently stand are woefully inadequate, permitting a system of payment that encourages brokers to act in their own interest, not yours.
That system of payment is the commission system – specifically the payment of ‘trail commissions’ by banks to brokers. In plain English, that’s the ongoing fee the bank pays your broker for selling you one of its home loans.
The report, released on Friday, was written by the government’s in-house policy think tank, the Productivity Commission, and it was pretty scathing of the system as it stands.
It said the remuneration system was “broken” and “at times highly likely to motivate brokers [and possibly lenders] to act in ways other than in the consumer’s interests”.
Conflicts in the mortgage broking industry
The Productivity Commission’s findings were not news: it’s long been known that there are potential conflicts in the way mortgage brokers are paid.
Five months ago, the issue got a very public airing when the Commonwealth Bank admitted before the banking royal commission that the way it paid its mortgage brokers was conflicted.
The main concern is that brokers are essentially motivated to recommend not the loan that is best for you, but the one that pays them the highest upfront and trail commission.
And there is no legal obligation for them to act in your best interest.
Last year, CBA’s then-chief executive Ian Narev admitted current commission structures could lead to “poor” consumer outcomes, and said CBA would support “elevated controls”.
In other words, the issue is well understood. However, little action has been taken.
The issue is becoming increasingly urgent as more and more Australians are getting a home loan through a broker rather than directly through a bank. The Productivity Commission (PC) says more than 50 per cent of all new home loans now come through a broker.
In some ways, the Productivity Commission said this was a positive thing. It means smaller mortgage providers (i.e. not the big banks) can distribute their mortgages far more widely than they otherwise could. This lessens the massive advantage big banks have, with their huge network of branches.
However, the report pointed out that big banks have increasingly taken control of mortgage brokerage and aggregator firms. A prime example of this is CommBank’s mortgage brokerage Aussie Home Loans.
The New Daily recently ran an article looking at this practice, and the rather murky practice of banks ‘white labelling’ home loans.
This means the big banks often have control of the whole supply chain, or at least a sizeable chunk of it. This creates even more potential conflicts – the PC found brokers in brokerage firms owned by banks were more likely to recommend the banks’ products.
So what should we do about it?
The PC did not recommend banning commissions altogether. If you did that, it said brokers would have to charge customers a fee, causing customers “to desert brokers, and smaller lenders (and regional communities with few or no bank branches) would suffer much more than larger lenders, if customers were required to pay for broker advice”.
Instead, the PC recommended the government scrap trail commissions altogether, and only allow upfront commissions.
It should also ban ‘volume-based commissions’ – that is, when banks increase the commission the more loans the broker sells.
And the government should restrict penalties on brokers and customers who switch to a different mortgage provider – so-called ‘commission clawbacks’.
“Lengthy clawback periods act against consumer interests, inducing a costly form of loyalty,” the PC said.
To ensure brokers act in the interest of their customers, the PC recommended a ‘best interest obligation’ – a law obliging mortgage brokers, aggregators and banks alike to act in the best interest of their customers.
Finally, the PC said banks or mortgage lenders should be required to have a “Principal Integrity Officer” – a sort of in-house informer to report any actions to the regulator that compromise the best interest of customers.
The ball is now in the government’s court. Treasurer Scott Morrison did not address the recommendations on commissions and the best interest obligation.
However, he did say the government would give “very serious consideration” to the idea of a ‘Principal Integrity Officer’.