Banning mortgage exit fees would enrage consumers

Mortgage exit fees are an unpopular beast within the larger banking ecosystem says Darren Moffatt, managing director of financial services company, Seniors First.

“Let’s face it, no one likes bank fees. Well, maybe bank CEO’s and shareholders are quite fond of them, but for pretty much everyone else they’re about as popular as whooping cough,” he wrote in an online blog.

“In the wake of record bank profits and the ensuing public and media hysteria over the Commonwealth Bank’s 0.45 per cent rate hike, I understand the government’s desire to do something now. But they had better be very careful when it comes to mortgage exit fees, because these aren’t just any garden-variety fees. They happen to underpin the fragile eco-system that is mortgage broking and non-bank lending in this country.

“The abolition of these fees, particularly without any remedies for the non-bank lenders, could have calamitous effects for competition, the mortgage industry, and ultimately, consumers.

“Over the last 20 years, the mortgage broking industry has developed as a key distribution channel for lenders to reach the mass consumer market. It was originally pioneered and championed by non-bank lenders such as RAMS and Wizard (both since swallowed whole by major banks) because it was a low cost alternative to the expensive bricks and mortar branch networks that the banks relied on for distribution. By the late 90’s, the broker channel was so effective in building market share for the non-banks that the banks themselves began riding the wave to the point where nearly 50% of all new mortgages in Australia are now originated by a broker.

“So, it’s perfectly clear that non-bank lenders and mortgage brokers have been fantastic for mortgage lending competition in Australia,” writes Mr Moffatt.

“One of the few downsides however with the non-bank model is that their loan origination costs have typically been higher than banks because they have a greater reliance on paying ‘upfront’ commissions to mortgage brokers in order to secure new customers. In order to recover these costs, and maintain profitability, mortgage exit fees have been charged if the loan has been paid out in full within the first five years. (It has to be acknowledged, that although banks also charge these fees, theirs have generally been less expensive).

“Given that mortgage exit fees underpin the entire non-banking model, what would happen if these lenders were forced to abolish exit fees?

“Well, profitability would obviously take a big hit. Some lenders would exit the market immediately, further reducing competition. But that’s not the worst of it. Not by a long shot. Of those lenders who stayed, a ruthless adjustment to the business model would be necessary for survival. Where would the lost revenue come from? A reduction in upfront broker commissions, or increased fees and rates are the two obvious areas.

“It’s quite apparent that any significant rate or fee increase payable by consumers will even further diminish the competitiveness of the non-bank lenders. Some lenders might try this anyway, but my guess is that cutting or abolishing broker commissions would be the first step non-bank lenders would take. Indeed, some providers have already publicly indicated this is on the cards.
 
“Now, some might ‘say who cares?’ However, the chain reaction this could set off is very scary indeed,” continues Mr Moffatt.

“Firstly, most of the 10,000 or so mortgage brokers in Australia rely on this ‘upfront’ income to cover their operational costs. If the non-bank lenders – the traditional innovation leaders – cut or abolish upfront commissions, what will banks do? They’ll quickly follow suit, of course. After all, they already have 90% market share, so why would they pay more than they need to?

“The mortgage broker community has already shed about 20% of its base due to the GFC and is currently losing hundreds more as the new NCCP credit regulation (in itself, a good thing) comes into effect. If banks cut or abolish upfront commissions (on top of the 40% reductions they introduced in 2008), probably half of the mortgage broker population would leave the industry. This would significantly reduce the non-bank lender’s distribution capacity, further cutting sales and profits in a vicious cycle that would pretty quickly collapse the broker channel and non-bank lender market into irrelevance.

“Now the point of this is not to garner sympathy for the mortgage industry. Change and legislative risk is a fact of business life. The fundamental point is what would all this mean for consumers?

“A hollowed-out broker channel and non-bank lending industry would drive borrowers back to the dark ages of the 70’s and 80’s. Less choice. Less product innovation. Higher bank interest rates and more fees. But most humiliatingly of all, consumers would again be forced to go cap in hand to the bank branch for their mortgage finance. Is this how modern, time-poor Australian families want to organise their mortgage finance?

“The government would have a tough time explaining to angry, voting, working families why they could no longer see a mortgage broker in their own home after a hard day’s work, but were instead forced to take time off, losing pay in the process, to queue in the bank for a more expensive mortgage.

“This is not progress. This is the opposite of progress,” he writes.

“In support of its case, the government (and the opposition) will argue that mortgage exit fees are an impediment to switching banks. This is a manifest fallacy. A few months ago The Mortgage and Finance Association (MFAA) published a submission to ASIC that showed, based on ABS figures, that refinances average between 30-35% of all established dwelling mortgage loan settlements each month. A healthy number, by any measure. This indicates that borrowers are switching lenders with relative ease. There is simply no evidence for the need to legislate for the removal of mortgage exit fees.

“No one likes fees, well almost no one. If mortgage exit fees could be abolished without the likely devastating consequences for industry and consumers, I’d be all for it. I hope the government does have a plan to deliver this. Unfortunately, its form with the big banks is not encouraging. When it allowed them to purchase St George, Bankwest, RAMS, Challenger and others during the GFC, the banks made assurances this wouldn’t reduce competition but would instead strengthen the banking and financial system. Now look where we are: the market share of non-bank lenders has halved from 20% to less than 10% in just two years.

“The banks currently collect about two hundred and fifty million dollars in mortgage exit fees each year. If these fees were abolished – without sufficient remedies for the mortgage industry – it seems to me that the loss of this revenue is a small price the banks would be happy to pay in order to completely eradicate the feeble competition that remains.” 

The blog is available at http://www.openforum.com.au/blogs/darren-moffatt