Brokers are the most popular way to find a home loan, but a new report suggests that banks should sell direct to the public instead. Professor Allan Hodgson asks if phasing out brokers could reduce competition and result in a worse deal for home buyers and smaller banks alike.
Up to 80% of mortgages are now arranged through mortgage brokers. However, what is not well known by the general public is that brokers are the most expensive way to find a home loan. Internal research by UQ Business School estimates that obtaining a mortgage through a broker will on average cost a home buyer $3,500, compared to less than $500 by applying online or $2,600 by going directly to the bank.
Yet brokers remain the most popular source of mortgage finance with consumers, perhaps because the costs are not transparent. Behind the scenes, the broker will typically receive an upfront fee of 0.65% of the mortgage value from the bank, plus annual commissions of 0.15% until it is repaid.
Not only are brokers more expensive, but now they also stand accused of putting banks’ financial stability at risk. The recent Sedgwick Report (2017) claims the use of brokers reinforces a sales-based culture in banking. Because higher commissions are conditional on the amount of the loan advanced and the amount outstanding, brokers write a higher level of fixed interest rate mortgages that attract higher annual commissions and are 25% more likely to go into arrears.
The danger of a sales culture is represented by the collapse of the US subprime mortgage market and the global financial crash (GFC). Research by Andrea Beltratti and René Stulz found that US banks with a sales culture were the ones who came off worst in the crash – even though they were outperforming beforehand. These banks earned a positive return of 38.8% in the year before the GFC and a negative return of 85.2% during the crisis, compared to 25.9% and negative 15.1% respectively for the more conservative banks.
Whilst making direct comparisons with Australia is problematic, it does highlight practices that are inconsistent with the interests of shareholders, and ultimately mortgage holders. One factor emerging from the Sedgwick review, conducted on behalf of the Australian Bankers’ Association, is its dissatisfaction with mortgage brokerage providers.
Sedgwick comments that brokers provide only basic services that many customers could do for themselves online. It makes a number of recommendations aimed at switching banks away from the current system involving brokers, and the associated sales campaigns and volume-based incentives that pay ongoing fees based on loan size.
One idea is for banks to offer fixed salaries to attract internal high quality mortgage advisors – a complete contrast to the present situation where they rely on third party brokers whose pay is dominated by commissions with the real cost hidden to customers. Another idea is to tie variable reward payments to a “holistic approach” that takes into account a range of customer-focused satisfaction metrics.
But will customers be persuaded to switch from brokers and deal with the banks directly? Brokers are perceived as providing a competitive service that trades-off banks to obtain special deals. They smooth the process by handling the paperwork, provide alternative application avenues to customers, and undertake negotiations that reduce the time to approval.
A market survey carried out by Deloitte for the Mortgage and Finance Association of Australia (MFAA) reinforces these perceptions. Brokers’ customers tend to be more satisfied with their experience than dealing directly with the bank; they see brokers are more likely to act in their best interests and as providing a personal service which is preferable to applying online. They seemed to be comfortable with the current fee arrangements. However, they also seem to be unaware of the true costs - 37% said that they would go direct to a bank if they had to pay fees up-front whilst most others set the maximum cost they would pay at $1000.
Moreover, removing mortgage brokers from the equation would disadvantage small banks to a greater degree. Brokers minimise the fixed costs for small banks by removing the need to expand and maintain a branch network.
Consequently, enacting Sedgwick is certainly not straightforward! How do banks convince customers that using their new internal ‘home lender’ service is in their best interests, when they are clearly dissatisfied with the present service? How should banks reveal the true costs of brokers’ commission – and should they charge the broker’s fee up-front? Will a move towards appointing fixed salary employees disadvantage smaller banks and mortgage loan companies who would struggle to attract high quality internal candidates? And would phasing out mortgage brokers reduce competition in the market and eventually lead to higher costs for customers?
Banks will need to address the concerns of Sedgwick by undertaking a trade-off between the sales-focussed brokerage service - seemingly favoured by the general public - and a move towards in-house home lenders. One thing is clear. Direct application through digital channels is by far the lowest cost option - but highly unpopular with customers. Herein lies a marketing and branding challenge - an area where banks have significant recent failures!
Allan Hodgson is Professor of Accounting and Finance at The University of Queensland Business School and is a member of the Retail and Business Banking Industry Council of FINSIA. Allan teaches the Honours class in empirical finance where students undertake research in banking and insider trading and the MBA finance class where students undertake case studies in winner/loser portfolio construction and in stock valuation.