You only have to hear the words ‘trailing commission’ to elevate your heartbeat up a notch or two.
It conjures up the very thing that people detest about financial services. That is, that someone is quietly, and secretly, taking a clip of their money.
Just like that ad on TV, where the sales person can’t hide their glee as a thick wad of cash suddenly appears in their hands. The reality soon dawns. The clients see themselves as victim to yet another sales job — feeding a greedy system that puts their own interests above that of the client.
The action of the banks undoubtedly generated the greatest level of public anger at the royal commission. It seems that some will only determine the commission a success if a banker goes to jail.
Yet there was another group — also a part of the home loan industry — that felt the commissioner’s ire…mortgage brokers. Yesterday, one prominent commentator even called for the whole industry to shut down.
The fuss is all about the way banks remunerate these brokers. In particular, the style of commission structure they use.
There is little doubt that some brokers prospered well in the real estate boom. Houses kept going up in value, meaning bigger loan sizes and commissions.
It was also the same with real estate agents. By taking a fixed clip on a sale, their commissions grew along with the market.
Typically, when a broker sells a loan, they receive two types of commission. One is an upfront fee, which is a fixed percentage of the loan amount.
The second part is a trailing commission. That is, another fixed percentage of the loan amount, paid to the broker every month.
While nobody likes the concept of a trailing commission, the brokers see it as a part of their fee. Or in other words, the fee they receive for writing a loan is broken into two parts — the up-front, and the trail.
Without the second part, the trailing commission, they argue that they could not survive on the up-front commission alone. They would all go broke.
Selling home loans is one of the more competitive businesses
Unless you have a decent chunk of savings behind you, doing a job that relies on 100% commission is way too hard for most.
But this is the way it is for many mortgage brokers. Unless the company they work for pays some kind of base salary, they rely purely on their selling skills.
They never know how much they will earn. Nor when, if at all, a decent pay check will come their way.
Add in the crazy hours and fierce competition, mortgage broking is a pretty tough gig. Clients might call at 6am on a Sunday morning for a loan update. Or, ask the broker to come to see them at 9.30pm on a Friday night.
The broker knows that if they don’t go, another broker will.
And unless the client takes out a loan, the broker doesn’t receive a cent for their troubles. It is all on their own time and expense.
Even if a customer actually signs on the dotted line, there is still another big obstacle. That is, getting past the client’s existing bank.
Banks’ dreaded retention teams scupper many, many a deal. Just as a broker thinks they have a loan across the line, the retention team from the client’s existing bank gets to work. They might offer anything from a special interest rate to no fees, to keep an existing client on their books.
Another thing is that once a broker has written a loan, it is not a set and forget. Homeowners and investors are always chasing the best deal.
A client might look to refinance every few years. If they go with someone else, the broker loses the trailing commission they rely on.
It’s a bit like a bucket with a hole in the bottom. The broker has to keep topping up with new clients as others inevitably go somewhere else.
All that is just part of the deal. Selling home loans is one of the more competitive businesses there is.
So what next?
One of the recommendations from the commission was that clients, and not banks, should pay the fee to the broker. That by paying commissions on the volume and size of the loans, the banks are encouraging brokers to write bigger loans than the customer might need.
It could also encourages brokers to sell loans that are not always in the clients’ best long-term interest. Like low-deposit and/or interest-only loans.
But why would a client pay the broker a fee? Unless they have had some type of credit trouble in the past, they could walk straight into a bank themselves and apply for a loan directly.
However, this comes back to the role of the broker. Their role should always be to find the client the best deal. And that means not having an allegiance with any bank. A bank will, of course, only sell their own products.
It also enables other banks to lend, increasing competition. For example, regional banks like Bendigo and Adelaide Bank, or Bank of Queensland, don’t need a national retail network to sell loans outside their home base.
And this is where the banks come back into the picture.
Mortgage brokers only receive commission when they write a loan. In other words, brokers, and their aggregators, are on 100% commission from the banks. As a core distribution arm of the banks — who write in excess of half of all loans — that makes brokers incredibly cheap (off the books) staff for the banks.
This broker distribution arm does not cost the bank a cent until a loan settles. That has to save the banks untold millions from selling loans through their own network.
Consider the cost of all those salaries, training, cars, annual and personal leave, overtime and other expenses. What would a bank have to pay to get an employee to spend a Sunday afternoon with a potential client?
You can be sure that banks will want to keep this cheap distribution arm. What business wouldn’t want to only have to pay someone after they generated a sale?
In saying that, though, they will certainly use the commission’s findings to try to screw the broker commissions down.
And if the banks aren’t happy with the way a broker operates, they can quickly, and relatively quietly, revoke their distribution agreement.
Both sides of politics are working their way through the royal commission’s findings. And my bet is that plenty of lobbying is going on behind the scenes — from both the banks and brokers.
Don’t be surprised if the mortgage broking industry survives for yet another day.
Editor, Options Trader
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