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Australian Credit Licence CPD
Mortgage brokers may have dodged the proverbial bullet with the return of the Coalition to government. Commissions may be safe for three more years, but that doesn’t mean it’s all smooth sailing for your average broking practice.
In February, Commissioner Hayne sent shockwaves through the mortgage broking industry when he recommended that commissions should be phased out completely. Brokers were up in arms, pointing to countless research which showed not only that consumers would not pay upfront fees for their services, but also that the flow-on effect would be the closure of thousands of broking businesses.
Despite initial promises to implement all of Hayne’s recommendations, the Morrison Government has pledged to leave commissions in place for the next three years. Cue sighs of relief all round!
But the furore does highlight some of the cash flow challenges faced by broking practices, such as the impact of clawbacks and the new utilisation calculation for upfront and trailing commissions.
In 2017, in response to the ASIC and Sedgwick reviews of broker remuneration, the Combined Industry Forum (CIF) proposed a series of measures to address potential conflicts of interest caused by commissions. Most lenders have now introduced the CIF-recommended change which sets out that upfront and trail commissions can only be paid on the drawn down amount, i.e. the loan amount, net of any offset.
Seems fair in principle, but this measure can lead to serious cash flow problems for brokers if the client does not proceed as expected with their property purchase.
Signs of dangerous seas
For example, a client discloses that they intend to buy a property for $750,000. They have a $250,000 deposit, so they borrow $500,000 and ask for a product with an offset feature. The loan settles and the broker is paid an upfront commission on the $500,000.
Within two months of settlement, the client finds a cheaper property and only draws down $400,000. Under the CIF model, the broker must repay the commission paid on the unused $100,000.
Using the same example, imagine if the client decides to put their $250,000 deposit into their offset account until they are ready to make a purchase? They’ve effectively halved the commission payable.
A third risk to the broker’s cash flow comes from the Partial Repayment Clawback Model. Nine months after settlement our client receives a windfall of $150,000. They use the full amount to pay down their loan, reducing the balance to $350,000.
In all these scenarios, the broker has already received their upfront commission and now needs to repay it. Similarly, the reference amount for calculation of trail commission has also reduced. While there are facilities for the broker to recoup the clawback from the client, strict disclosure rules apply and there is no guarantee the client will pay in a timely manner. And there is no recourse open to the broker for the trail reduction. Similarly, third-party referrer arrangements, in which a percentage of the commission is paid to the referrer, can also adversely impact the broker’s cash flow when clawbacks come into play.
“We sympathise with brokers struggling to make sense of and adjust to the shifting commission climate. We look forward to regulators and lenders clarifying the way forward. Then brokers will be in a better position to fine-tune their practices and more definitively formulate their value proposition to clients in the revised landscape,” says Financial Education Professionals Industry Capability Manager, Belinda Brown.
Riding out choppy waters
The good news is that some lenders have begun to remove partial repayment clawbacks for loans where funds are not utilised in the first six months after settlement. It is, however, unwise to limit your product recommendations based on the remuneration model offered by the product provider. Not to mention you run the risk of being targeted by regulators who have increased their scrutiny of loan suitability and the looming prospect of a best interests duty for brokers.
So, how can brokers continue to build profitable, sustainable businesses in spite of the ever-present threat of commission clawbacks?
Here are some strategies to consider:
- Prepare your clients for the prospect of clawbacks early:
- Review your Credit Guide to ensure it allows for charging of fees and references your Credit Quote
- Explain the possibility of clawbacks upfront, even if they seem highly unlikely
- Issue a Credit Quote that incorporates a clawback provision EVERY SINGLE TIME
- Inform third-party referrers about potential clawbacks
- Get closer to your clients:
- Build additional questions into your Fact Find to get a clear picture of your clients’ intentions for the funds
- Look for risk factors that may impact the client’s ability to repay the loan, switch providers or make large repayments
- Stay in regular contact with your clients after settlement so you have advanced warning of changes to their financial situation
- Stay on top of your cash flow:
- Contact your client (and your referral partner) as soon as you become aware of a clawback to explain what is required
- Use software like Xero and MYOB to generate your invoices, as they include auto-generated reminders on your behalf
- Analyse monthly cash flow reports
- Plan ahead for the impact of slow periods/staff holidays
- Charge a refundable fee:
- Offset cash flow risks by charging all clients a refundable fee that covers potential losses due to clawbacks/reduced commission
- After 2 years, if no clawback has been implemented, refund the fee to the client
- Clearly set out the terms of the fee in your disclosure documents and make sure your client understands the purpose of the fee
Governments, regulators and lenders are always moving the flags. But by implementing some proven practice management techniques, you can keep your head above water and see you and your clients safely and delightfully riding every mortgage wave.
Authored by Therese O’Neill
Therese O’Neill, a professional mortgage industry adviser and mentor, is a member of FEP’s practitioner faculty and a regular industry news columnist.
Financial Education Professionals covers broker remuneration and commission clawbacks further in its Australian Credit Licence CPD.