As at February 2015, residential mortgage loans in Australia totalled $1.44 trillion, and of all the new loans originated each year mortgage brokers are now responsible for over half of them.
This post explains what mortgage brokers do why they have become so popular.
Background
To get started, in order to understand the role of a mortgage broker it’s important to first understand some background about the industry.
Australia has a strong tradition of home ownership with rates of home ownership remaining fairly stable at around 70% over the past few decades.
But until the early 1990’s it was far more difficult to obtain a loan than it is today. Interest rates were high and the market only comprised the big banks (back then CBA was government owned) as well as small number of credit unions and building societies. Aspiring borrowers required large deposits, they would have to go into a physical bank during limited branch opening hours (10am-3pm) and then submit time consuming, paper based applications. The service offering was poor and the banks would often require borrowers to take out two mortgages, the second at even higher interest rates. Many borrowers whose income was low, irregular or who had any kind of impaired credit history were flat out denied credit.
In the early 1990’s Australia’s financial system was deregulated, and this led to the emergence of “non bank” lenders, which changed everything. Deregulation allowed for this new breed of lender to offer mortgages without the requirement of holding a banking license. They were not allowed to take on deposit savings – the main source of loan funds for traditional banks – so they instead sourced their loan funds from wholesale capital markets (e.g. sophisticated investors via a process known as securitisation). The non banks undercut the interest rates of traditional banks and quickly captured ~15% of the mortgage market.
In order to compete the traditional banks reduced their own interest rates, and to maintain profits they closed as many as 2,000 branches across Australia. This left many mortgage lending officers and bank managers unemployed.
The Australian mortgage market of the mid-90’s all of a sudden looked a lot different:
- more lenders for borrowers to choose from
- more products for borrowers to choose from
- more innovative and/or sophisticated products being developed to win customers
- non bank lenders without bank branches to sell their products
- traditional banks, building societies and credit unions with less branches to sell their products
- lots of experienced mortgage lending officers and bank managers — unemployed
It was through this dynamic that the mortgage broking industry was born.
The pioneers of the industry seized on the opportunity to assist lenders by selling their products, and to assist borrowers they offered access to a more diverse range of products (e.g. those offered by all the various lenders) as well as better customer service.
The role of mortgage brokers, and their value proposition
Fast forward two decades and these are largely the same services offered by mortgage brokers today:
- evaluate the borrower’s situation/preferences and recommend the right product(s) from across all the different lenders
- provide better service to borrowers by doing all of the legwork and paperwork for them, being available 24/7 for meetings and support (not just during bank opening hours) and by offering advise/expertise throughout the life of the loan rather than just at the beginning of the process
- the service comes at no additional cost to the borrower, because mortgage brokers are paid by the lenders
And then there are the better mortgage brokers who go further:
- assist clients (particularly those with multiple properties) structure their loans correctly, in such a way that’s tax effective and maximises wealth creation
- provide referrals to expert financial planners, accountants, solicitor/conveyancers and buyers advocates
Over the past two decades Australia’s decreasing interest rate environment combined with more mortgage products from an increasing number of lenders entering the market has helped mortgage brokers demonstrate their value. By January 2002 mortgage brokers had established a retail market share of ~18% and this grew to ~40% by 2007. As of August 2015 mortgage brokers now account for over 55% of all mortgage originations.
From the lender’s standpoint brokers have proved their worth too. When a bank operates a branch it has to pay rent and wages regardless of how many people walk through the door — there are a certain amount of fixed costs. Mortgage brokers effectively provide banks with a national ‘on demand’ salesforce, and by paying brokers on a commission-only basis it only costs the lender money when their products are actually sold — this cost is variable.
Physical branches still play an important role for other reasons and therefore will never be eliminated completely, however they are more concentrated now around higher density areas.
Brokers are also crucial for non banks who have zero branches. For these businesses (including Macquarie Bank), mortgage brokers typically account for 90%+ of originations.
So what are the alternatives to using a mortgage broker… where do the remaining 45% of new mortgages come from?
Alternative to brokers #1 – Going direct to the bank
Many borrowers still go into a bank branch and discuss their needs with an in-house lending specialist.
It may be the case that they have a relationship with someone in the branch or perhaps they researched their preferred lender online and then chose to approach that lender directly. It also might be the case that the borrower didn’t know any mortgage brokers, or even know they existed.
Whatever the reason for going direct, the main downside of this approach is that the borrower is limited to the offerings of that one lender only, whereas an alternative lender may be offering a superior product or better pricing elsewhere.
Another issue to be mindful of is the risk of having your loan application declined. If you’re still in pre-approval stage it’s not the end of the world (although the enquiry will still show up on your credit profile), however if you have purchased and then get declined you are at risk of incurring penalty interest, losing your deposit, or even being sued.
A good broker in this situation would understand why your initial application was denied and have a better chance of being able to get you approved elsewhere, and quickly.
Most banks now also have ‘mobile lenders‘ whose job it is to meet you at your preferred times and locations. This service is available outside of regular business hours, which is a plus, however the above issues of pricing, product limitation and approval risk still remain.
When you go to a lender directly you at least eliminate the risk of dealing with a bad broker. Not all brokers are created equal and like with any industry there are good operators out there, and there are bad. Those with limited product/industry knowledge and poor service offerings are the bad ones.
The lenders whom you would deal with directly are much larger companies with bigger reputations to uphold, so by going direct there’s the possibility of at least receiving an adequate level of service. So it depends what your expectations are.
Note that as at April 2017 many banks are raising interest rates and tightening credit policies in response to regulatory pressures set by ASIC and APRA. It’s becoming an increasingly challenging lending environment and this is benefiting brokers in the form of increased market share. Having access to 20+ institutions is a major advantage, and as a free service to consumers it’s very compelling. (see my No one’s going to their bank anymore article for further details)
Alternative to brokers #2 – The internet
There are many ways for a borrower to get a home loan online but because mortgages are generally the largest financial commitment one makes in their lifetime most borrowers still prefer talking to someone in person.
A lot of borrowers do their research online – and there are a number of home loan comparison websites which make this process easier – but then work with a mortgage broker or lender to actually obtain the loan. (note that about half of the Australian comparison websites refer borrowers to brokers, and the other half pass on referrals directly to the lenders, none actually provide the loans themselves).
In addition to most lenders nowadays offering online applications there are also a new breed of “online-only” mortgage lenders entering the Australian market, and they are slowly growing (but still insignificant in terms of market share).
These operators don’t rely on broker referrals as a source of new customers which means they do have genuine cost savings to pass on (more on this below).
They make sense for uncomplicated loans where the borrower is highly rate sensitive and content with a “self service” approach, generally aided by a call centre and online chat for basic support.
Online-only lenders are less suitable for sophisticated borrowers who have complex lending requirements (e.g. multiple loans, multiple security properties and complex ownership arrangements).
A note on commission payments and pricing
Mortgage brokers are required by law to disclose the commission payments they receive from lenders. If you go direct to a lender they won’t have to pay a broker any commission, however this cost saving is not passed onto borrowers in any way.
For example the price of CBA’s standard variable rate loan is the same regardless of whether you obtain it through a broker, or directly through the bank. The same goes for establishment fees and any ongoing fees.
It’s counterintuitive but borrowers can often obtain better pricing by going through a broker, because brokers have experience negotiating with lenders on your behalf for the best discounts.
Online-only lenders do pass on the cost savings of broker commissions however other traditional lenders can often match or come close to matching online-only lenders on price, particularly if the borrower commits to a package deal (e.g. a credit card with rewards and transaction savings account, on top of the home loan).
What to watch out for with mortgage brokers
Since December 2009 all mortgage brokers in Australia have been required to hold an Australian Credit License from the Australian Securities and Investment Commission.
Before then the regulation behind credit and related services was less stringent and resulted in the existence of some unethical ‘cowboy’ operators in the industry. Fortunately many of these operators were eradicated by ASIC however as previously mentioned there are still brokers out there who may not deliver the type of service you would expect when undertaking a process as significant as buying property.
Be careful of brokers who are too sales focussed and less interested in catering for your specific needs. Also be careful of brokers who immediately recommend a particular product or lender without due consideration for what else is available in the market.
In our next post we’ll start breaking down the mortgage process in more detail so you can get a better sense of everything involved. Suffice to say though it’s a complicated undertaking so you’ll be well served working with a broker who communicates with you regularly and professionally throughout the process.
How to find a good mortgage broker
Something few people realise about the mortgage broking industry is that the quality of operators is more transparent than in many other service driven industries. Every year associations like Mortgage Professional Australia, The Adviser and Australian Broker publish a list of top brokers (and brokerages) based on the volume of business they generate.
In 2016 the Australian Lending & Investment Centre was well represented in the MPA Top 100 with 2 of our 4 brokers making the top 5. (you can see my post on this here)
So out of the 12,000 or so mortgage brokers operating in the Australian market it’s not difficult identifying the better ones.
A mortgage broker who writes more business isn’t necessarily a better broker, however borrowers are obviously using (and referring) that broker for a reason.
Look for brokers who can demonstrate knowledge, professionalism, integrity and results. Find others whom have previously dealt with the broker you’re considering, and ask them about their experiences. Don’t be shy asking anyone tough questions.
