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ISCOVER
Regulators and advisory bodies have shared their scepticism of lender-paid broker remuneration, questioning whether the industry can really act in the best interests of customers under the current model. Tas Bindi takes a closer look at the feasibility of introducing the fees-for-service model in the mortgage broking industry.
It's been three months since I entered the world of mortgages through my new journalist position at The Adviser, and it feels like it’s been non-stop chaos for brokers throughout this period. I get the sense that brokers are bystanders being pounded by regulators and government advisory bodies as part of their broader investigations into the financial services industry.
The Productivity Commission (PC) made clear its concerns around the current lender-paid broker remuneration model, which it believes creates “perverse incentives” for mortgage brokers to act in their own interests rather than the consumers’. The PC presented the fees for service as an alternative model, where the consumer pays for the broker’s service, rather than the lender, to ensure their interests are served without any conflicting commercial influence.
The proposition was met with strong criticism from the mortgage broking industry, with the overwhelming consensus being that standardising such a model will have a number of adverse effects, including: reducing the number of consumers who can access mortgage advice, hindering competition among lenders and putting brokers at a disadvantage to the lender branch channel.
Based on the average commission figures recorded by the Australian Securities and Investments Commission, brokers would need to obtain about $3,400 from the customer to replace the upfront and first year of trail commissions usually paid by lenders, which cover the significant labour and business costs associated with mortgage broking (for example, most brokers say they spend five to eight hours per client application, depending on its complexity).
So, how would charging fees work in practice? Melbourne-based brokerage My Mortgage Freedom charges customers between $396 and $800 (inclusive of GST) once off based on the complexity of loan applications.
The brokerage arrived at this price after analysing the time spent on initial conversations with a client to understand their circumstances and requirements, researching suitable loan options, constructing and explaining recommendations, and preparing loan applications. After identifying a reasonable hourly rate, the brokerage decided that the minimum cost of $360 plus 10 per cent GST made sense.
But this is in addition to the upfront and ongoing trail commissions My Mortgage Freedom receives from lenders.
Founder and CEO Anthony Alabakov explains that his brokerage started charging service fees because the commissions paid by lenders have reduced over time, while the broker’s workload has increased due to changes in lender requirements and policies and legal reforms.
However, while the brokerage has embraced the fees-for-service model, Mr Alabakov does not believe it can fully replace lender-paid commissions because consumers would have to fork out thousands from their own hip pocket for the model to be sustainable for brokerages.
He says that clients do ask “all the time” why they are being charged a service fee, but nine out of 10 times, the client accepts the charge once the benefits of using the brokerage’s services are explained. (The remaining client is normally a “rate chaser” seeking the lowest interest rate, Mr Alabakov notes.) But, according to the CEO, customers are willing to pay for a “holistic service”.
As such, Mr Alabakov says that mortgage brokers need to expand their horizons and not just see themselves as mortgage brokers.
“[Brokers] just need to think outside the box about where they want their business to go,” the CEO says.
While Mr Alabakov does not envision My Mortgage Freedom charging customers thousands of dollars to replace commissions, he believes that fees can be increased incrementally over time.
“If commissions do go… I’m going to make sure it’s not the end of the world,” Mr Alabakov notes.
“And, if it does happen, I don’t think it’ll happen overnight. I think there will be some time for companies to adjust; it will probably be phased out over time.
“We’re just trying to arm our business to be sustainable by [charging fees] now.”
Learning from history
Financial planners have been through something similar to what mortgage brokers are currently facing. The Future of Financial Advice (FoFA) reforms banned “conflicted remuneration” structures (including commissions and volume-based payments) on all financial product advice and mandated the introduction of an opt-in mechanism that requires financial planners to ask their clients (every two years) if they would like to continue receiving advice.
Anecdotal evidence suggests that the reforms had adverse impacts on financial planners. For example, Mr Alabakov says that witnessing his father’s experience motivated him to be proactive and prepared for upcoming changes (whatever they may be).
ASIC’s investigation in 2013–14 of the immediate impacts of FoFA reforms found that financial planners’ revenue streams changed as a result of the ban on conflicted remuneration, eventuating in a reduction in the value of investment commissions and a rise in fixed advice fees.
However, at the time, the difference in revenue was not significant (ranging from 2 per cent to 5 per cent). In fact, Australian Financial Services licensees cited the administrative burden around changes to fee disclosure statement regulation as their top concern at the time.
While mortgage broking and financial planning are different industries with different client needs, the FoFA reforms’ impact on financial planners could provide insight as to the feasibility of introducing service fees to mortgage broking.
The founder of Finance Made Easy, Tony Bice, who is both a financial planner and a mortgage broker, says that while he specialises in risk insurance and superannuation (and is paid by vendors under similar commission-based models), his firm began charging clients a fee for the preparation, rolling over and management of their superannuation funds.
Mr Bice says that the company structured the model so that a small percentage of the client’s superannuation is automatically deducted from their fund to ensure there was “no impact on the client’s back pocket”.
But when it comes to mortgage broking, Mr Bice does not believe that the fees-for-service model can be replicated in the industry.
In fact, the Finance Made Easy founder reveals that he attempted to introduce a “commitment fee” years ago; the customer was “charged” $500 but received a 100 per cent reimbursement upon settlement.
“It was to make sure that the client committed to the transaction and didn’t go off to another broker after a lot of the work has been done,” Mr Bice explains.
He says that clients were unhappy about the extra charge, even when it was explained to them that the $500 would be fully repaid once the home loan reaches settlement.
“Imagine trying to charge a client $4,000 to do their loan… Maybe if we were having this conversation 20 years ago when the mortgage broking industry was in its infancy, and it was [the norm] to pay to see a broker [so] clients didn’t know any better, then [fees for service] might make sense,” Mr Bice says.
He adds that the only way he could see the fees-for-service model working is if consumers are “somehow” convinced that paying a $4,000 fee to consult a broker is better than walking into a local bank branch and paying nothing.
“The reason three out of five clients go to see a broker is because of convenience, product knowledge, support, and if you want to throw one more on, [because] it doesn’t cost them anything,” Mr Bice says.
On top of that, the founder says that a lot of the work that brokers do on behalf of their customers are what lenders are required to do themselves when customers reach out to them directly.
As such, a common argument that has been made by the industry is it’s only fair that the broker is remunerated by the lender for reducing the lenders’ workloads and costs.
“The upfront fees that a broker gets plus the ongoing trail… whatever the dollar figure happens to be, you can be guaranteed that it’s cheaper than the old way, which was the branch network,” Mr Bice says.
What do consumers say?
Many brokers I’ve spoken to already believe that the commissions they presently receive are incommensurate with the work they do, and so they have difficulty envisioning a time in the future when they’re able to afford to charge customers less than $1,000 and continue operating a viable business.
They equally believe that the vast majority of Australians will be unwilling or straight up unable to pay thousands of dollars to a broker — especially on top of a hefty home loan — even it is offered in combination with other services with the option of paying incrementally.
It has been argued that introducing the fees-for-service model will only make mortgage advice inaccessible to those who need it the most, such as first home buyers.
For example, National Finance Brokers Day founder Dino Pacella says: “First home buyers [who] have been saving money for six to 12 months and they secure a 5 per cent deposit aren’t going to have the extra funds available to pay for [a broker]. So, they’re automatically going to go to the direct channel where there is no accumulation of fees charged based on their application.
“[Brokers are familiar with] the complexities in outside-of-the-normal tick-and-flick applications, which will continue to benefit the consumer, and so we need to ensure we’re not taking the opportunity away from the consumer to receive integral guidance and support when it comes to their loan requirements.”
So, what do consumers think? Their voices seem to be largely absent in these industry discussions. No large-scale studies have been done on the views and attitudes of residential mortgagors recently, so I asked a small group of my contacts whether they would pay a mortgage broker. Ninety-four per cent said that they would. The majority also indicated that they would pay up to $1,000, with only a few willing to pay more.
Further, a previous survey conducted by The Adviser’s sister publication, My Business, showed that 63 per cent of SMEs would be willing to pay service fees to brokers. These indicate that people are, at the very least, open to the idea of paying mortgage brokers for their knowledge and expertise.
“We need to ensure we’re not taking the opportunity away from the consumer to receive integral guidance and support when it comes to their loan requirements” – Dino Pacella, founder, National Finance Brokers Day
Do banks want to bear the broker’s cost?
ANZ and NAB have communicated their support for the lender-paid broker remuneration model during PC and royal commission hearings, while the Commonwealth Bank and Westpac indicated the opposite, arguing that there would be no conflicts of interest if it was the consumer’s responsibility to pay for the broker’s service.
While largely in favour of lender-paid commissions, NAB’s general manager of broker distribution, Steve Kane, wrote an email to brokers noting that it also supports the six reform principles agreed to by the Combined Industry Forum, such as: to tie the standard commission model to facility drawdown net of offset; the immediate cessation of volume-based and campaign-based commissions paid by lenders and aggregators; providing soft dollar benefits based on a balanced scorecard and good customer outcomes; and capping benefits given by lenders.
Upfront commission:
0.54% of loan settled
Trail commission:
0.14% per year (decreasing with time)
Example:
$500,000 loan would see brokers receive
$3,400 for upfront and trail
Fee for service:
$3,400 to cover the costs
(Source: ASIC)
While all types of lender-paid commissions have been criticised, trail has particularly confounded the PC, with chairman Peter Harris calling it “absurd” due to there being no performance standards around the ongoing care of customers.
Mr Pacella says that the reason trail commissions should stay is “because brokers are going to be doing more and more work with their current portfolio than they have done in the past”.
The founder says: “Given the amount of change that we’ve had in the regulatory environment over the last 24 months (and that is going to continue on), consumers are going to get more educated, they’re going to read more about what’s happening in the broker space [and] in the financial marketplace in general, and they’re going to reach out to brokers more often seeking changes [and] further advice.”
He does, however, support the introduction of a minimum annual requirement of one communication with an existing client, which he acknowledges that most brokers are already committed to.
The National Finance Brokers Day founder further notes that the fees-for-service model could not replace trail commissions as the consumer would be unlikely to see the value in paying their broker on an ongoing basis, especially if there are no variations on their loans.
“A basic review [of an existing home loan] doesn’t justify a $1,000 fee unless significant savings [will come from it],” Mr Pacella says.
Preparing for change
The sentiments communicated in PC and royal commission hearings suggest that change is coming to the mortgage broking industry. As the industry awaits direction from regulators, Mr Pacella says that brokers should focus on the things they can control.
For example, the founder suggests that brokers consider diversifying their service range if they haven’t done so already to future-proof their business, further noting the trend of medium to large-sized broking firms increasingly branching out to offer a “one-stop shop” for financial services customers.
He also believes that it would be worthwhile for brokers to adopt technologies that can help boost efficiencies and reduce operational expenses (however, whether efficiencies can be improved to the point that brokers can afford to reduce the cost of their service remains unclear).
Mr Pacella holds the view that if the industry is forced to adopt the fees-for-service model, it would need to be “aligned with the upfront commission model”.
He explains: “If the broker does five or six hours’ worth of work and the client’s situation has changed or the client takes the information [provided by the broker] and goes through the direct channel to fulfil their loan requirements, I don’t think the broker should be disadvantaged by the time already invested into that client.
“That’s when the fees-for-service model could potentially come in. But that needs to be completely transparent from the first interaction with a customer.”
As one should never say never, I’ve come to the conclusion that it will be very difficult to make the fees-for-service model work in the mortgage broking industry. When we’re talking about thousands of dollars, I would personally choose the cheaper option, which would be scouring the internet for all the information I can get about home loan deals, and then going direct to the bank that I feel has the best deal and a decent reputation.
But if it didn’t mean burning a massive hole in my pocket, I would pay to see a broker. I’m sure many others will, too.
In the meantime, as Mr Pacella and Mr Bice say, brokers should get on with business as usual and not let uncertainty impact their work.
TOP TIPS FROM A PRICING EXPERT
For brokers who are willing to test the fees for-service model, managing director at Elixir Consulting Sue Viskovic shares her top tips on pricing services
Ms Viskovic, who has authored and co-authored a number of books on adviser pricing models, says that brokers need to “get a handle on the cost to run their business”, determine their desired profit margin and identify the average time and resources spent on different processes as their first steps.
“Some of them probably haven’t done that before because the remuneration they receive is dictated by the work they’re doing and the bank that’s paying,” the MD says. “They created a business they can fund through the income they get, whereas fees for service is the other way around [in that] they need to consider the cost of their business and then determine how they’re going to charge.”
The next stage is to identify how much “chargeable time” they have in their business, though Ms Viskovic strongly advises against charging clients by the hour.
“They might say [they] work 40 to 60 hours a week, but in actual fact, they’re doing marketing, bookkeeping, networking, building referral relationships… none of that is chargeable time. So, it might be that 30 per cent of their time is not chargeable,” the MD says.
According to Ms Viskovic, brokers might find it easiest to do what a lot of insurance advisers have done, which is create a fee for the element they have control over — i.e. their advice.
“Their research on what’s available in the market, [understanding] the client’s personal circumstances, finding recommendations on [which lender the client] should go with, then helping them structure their debt, that’s all intellectual property that they can charge for,” Ms Viskovic says.
The MD adds that it’s important to be able to clearly demonstrate to clients the value they will get from consulting a broker. For example, it could be long-term savings through a discounted interest rate that is only available through the broker, subsequently offsetting the cost of mortgage advice.
“It’s going to be important for [brokers] to learn how to explain their services slightly differently… [They’re] going to have to get better at separating the value of [their] advice from the value of the product they’re implementing,” the MD says.
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