Following the recent allegations on BBC Radio 4’s Money Box programme that brokers who earn commission cannot be trusted, there was further criticism last week when a popular tabloid warned its readers about brokers who charge big fees. As usual with the tabloid press, the coverage sought to heighten the sensationalism by confusing sub-prime with prime lending as well as throwing secured second charge loans into the mix for good measure.
The article referred to the Financial Services Authority’s announcement that it was investigating claims that some brokers are recommending sub-prime deals to clients when prime deals are available, in an attempt to secure higher proc fees.
I doubt that any of us think there is evidence that this is happening on a big scale or that brokers are charging excessive fees. Of course, there will always be a few bad apples but statutory regulation has made it difficult for these rogues to trade.
I agree with brokers charging fees as the advice we give is valuable and we are not adequately compensated by the standard proc fees available on most prime deals. But I have a problem with the high fees being charged on some sub-prime deals.
We all know there is more work involved with sub-prime deals, although how much of that is down to inexperience in the sector and how much is driven by the greater degree of work I’m not sure.
To charge high fees is to take advantage of a vulnerable section of the market and brokers who do it will come under scrutiny from the FSA sooner or later.
Lenders have a responsibility here too, especially in light of the Treating Customers Fairly initiative. In an increasingly competitive market, some lenders are tempted to try and buy distribution by offering increased fees to packagers and brokers. This cannot continue.
Some brokers will tell you that the reason they charge additional fees is because this area of the market is fickle. Brokers want to get their fees upfront because of the work involved in getting cases to offer stage. Brokers now rarely sell insurance-related products due to the propensity for these policies to lapse in the early days, so those who would normally top up their proc fee income with insurance commissions seek to cover this gap with fees.
So what is a fair fee? There is no hard and fast calculation as each case is different but ask yourself – if you were asked to justify your fees by the FSA, could you?
Time to end this drive-by robberyWith the advent of automated valuation models, I hope we will soon see the end of drive-by surveys. I always thought a drive-by survey was a contradiction in terms as well as being one of the most unfair aspects of mortgage application costs.
In many cases, neither brokers nor clients know what type of survey is being carried out. And for a good reason – surveyors don’t want us to know how much money they are making out of this scam. It’s only when drive-bys are undertaken for remortgage clients that it comes to light – clients are not contacted by anyone to get access to their properties.
The Council of Mortgage Lenders claims that only 25% of remortgage valuations are done by drive-by surveys and it estimates that up to 55% will be done by AVMs by 2011. I think the CML is being a bit too cautious and I would be hugely disappointed if that figure was not hit by the end of next year.
Software that hit US sub-prime
Reminiscent of the plot of Terminator 3: Rise of the Machines, a little known piece of underwriting software could be to blame for the meltdown in the US sub-prime market.
While researching the problems facing the US sub-prime sector I came across an article first published in the New York Times in March this year. It talked about a piece of automated underwriting software developed for the sub-prime market by an ex-NASA engineer.
Historically, the US sub-prime market relied on manual underwriting on a case-by-case basis, pulling together the strands of individual borrowers’ credit files and financial histories. That all changed with the introduction of software that effectively collated all credit file information using the internet and then scored the risk of default using a complex set of algorithms.
Unfortunately, this allowed lenders to push the boundaries of risk further and resulted in them offering 100% loans and interest-only mortgages with little or no margins for error.
It was this software that allowed lenders to ride the crest of the US housing wave from 1999 to 2005. Since then, the housing market has suffered from higher interest rates and a cooling of property prices. This has sent defaults soaring and, as we have seen, pushed some lenders into bankruptcy.
Today, automated underwriting accounts for about 40% of all sub-prime lending in the US and while the software alone cannot be blamed for all the problems being experienced by the sub-prime sector, it certainly contributed.
By relying on machines, US sub-prime underwriters were lulled into a false sense of security and by the time they realised what was happening, it was too late.