As we work in financial services we are well aware of the need to ‘shop around’ particularly when it comes to products such as credit cards, loans, mortgages and bank accounts. Institutions who offer these products tend to rely on customer inertia when it comes to making their money where existing customers, who have not shopped around and stay put, tend to supplement the tempting offers that are on the table for those who are willing to make a switch.
In the second charge market we have tended to have something of a skewed version of this approach, specifically when it comes to fee-charging structures. Indeed, in this sector up until now, customers who complete on their loan have effectively been picking up the costs of those individuals who don’t make it through the process.
Currently there is only one viable option for the fee model – the customer pays a bundled broker fee to the master broker (who offers a ‘packaged service’) out of which they pay for valuation costs, lender reference charges, credit search costs, etc. That bundled fee only gets paid to the master broker when the loan is drawn down; indeed the fee is typically added to the loan at completion.
There are a number of reasons why this is the norm. Firstly, as second charge loans are still under the auspices of the Consumer Credit Act until 21 March 2016, a master broker can only take a maximum of £5 as an upfront fee. Hence why the fee is added to the loan and paid on completion. However, to make matters worse, if a case is cancelled during the packaging process, it is conceivable that the master broker may have incurred around £300 of valuation costs and also fees for those lender references and credit search requirements. This means the master broker has to create a degree of ‘fat’ within their fee structure in order to cover such ‘sunk costs’. In reality, those customers who do go ahead effectively subsidise those who don’t. A less than ideal situation in anyone’s book, making the Mortgage Credit Directive (MCD) changes particularly welcome.
In a positive regulatory move the future of second charge fees are likely to benefit from a far more flexible environment under the MCD. In the new world master brokers will be allowed to charge up-front fees, just as those active in first-charge mortgages can do – some mortgage brokers even collecting their broker fee at the submission to lender stage.
This presents two specific positive outcomes for master brokers and customers. Firstly, the fee will be much more transparent and the customer will be able to see how much of it goes to the valuer and how much is retained by the broker. Secondly, because the master broker can take some of the fee upfront if they wish, there is less pressure on recovering sunk costs by fattening the fee, meaning fees could potentially come down. In fact, in areas such as the valuer payment, the customer could pay direct providing even greater transparency around total cost.
Opting for this type of upfront fee appears to deliver some significant positives across the board. It clearly allows a master broker to create a fairer cost model and it is a good way of addressing the issues surrounding those clients who get some way through the process and then decide not to continue with the loan.
The Loans Engine will be exploring this new approach, not least because it goes a long way to addressing the ongoing concerns, voiced by some, that second charge broker fees have been too high. Our own experience is that this isn’t necessarily the case but there has been too little education and transparency around the real reason why fees have been pitched at their existing levels.
With the post-MCD option of upfront fees being available, we have the chance to create a virtuous circle for loan brokers, with only those customers who are most committed to proceeding actually submitting an application. Under the new regime the fee structure will be standardised, enabling a more consistent outcome for the customer. The fact that a lower fee should result from this also means more customers might apply, with the result that conversion rates go up (with improved operational efficiency) and written volumes of business also improve (creating market growth).
In essence, the second charge loan sector and customers, certainly when it comes to fee transparency, will potentially be placed in a far better position when the MCD changes come into effect.
Steve Harness is commercial director at The Loans Engine