Procuration fees for sub-prime business have traditionally been higher than for prime business, reflecting the heavier workload for the broker and the greater likelihood that the cases will not complete.
But as sub-prime mortgage rates move closer to the mainstream and technological advances speed up applications, could proc fees be heading for a fall?
Sub-prime lenders typically pay brokers fees of between 0.5% and 1%, depending on the level of adverse, and some pay more. Bristol & West, for example, pays 1.5% for broker business and 2% for packaged business regardless of adverse levels. Other lenders have broker fees of more than 2%. Prime lenders typically pay between 0.25% and 0.5%.
Last year, nearly a quarter of mortgage brokers said they expected regulation to push down sub-prime fees in their responses to the Future 500 survey. BM Solutions, GMAC-RFC, Future Mortgages, Kensington Mortgage Company and Mortgages PLC are keeping a tighter rein on fees to offer a better rate to the client.
There is a traditional defence for the differential between prime and sub-prime proc fees, and Julian Wells, head of marketing at Mortgages PLC, says this still holds good.
“There is more work involved in sub-prime deals and that is why lenders pay higher fees to brokers,” he says. “Although technology has progressed we haven't reached the point where lenders see a cost benefit because they have to provide for brokers who want to work online or offline.”
Some lenders have aggressively targeted online business but until the majority of brokers are working electronically, lenders won't save money.
“Applying online won't necessarily save brokers work as they still need to gather the information for the lender,” Wells adds. “They will get a faster response but that is because they have saved the lender the work of rekeying the application into their system. Why should the broker receive a lower fee for saving the lender work? They deserve a fair fee and we wouldn't cut fees if it would hurt relationships with our distribution.”
Bob Sturges, head of communications at igroup, says specialist lenders expect introducers to provide detailed information on their clients' individual financial circumstances rather than simply use automated credit scoring.
“Our risk assessors need this to reach the correct lending decision based on the customer's ability and willingness to honour their commitment. Our fees reflect this extra investment in time and effort by the introducer.”
And technology won't change this.
“Introducers in the specialist sector continue to provide a valuable service to customers denied access to traditional products,” adds Sturges. “Technological advances may speed up routine internal processes but more information is still the key to prudent risk assessment and we continue to rely on our introducers for this.”
But David Bitner, head of product operations at The Marketplace, says higher fees can no longer be justified by claiming sub-prime involves a lot more work for the broker.
“If the broker gets all the relevant information from their client prior to placing the case there should be less work. With fewer lenders and products it is relatively straightforward to select the best deal based on the level of adverse credit. And if you choose the best product and lender there is no reason why the case shouldn't complete.”
Lower proc fees won't necessarily harm brokers but they will certainly help their clients.
“Lenders can feed that saving back into their products, making them more competitive and increasing overall levels of business,” says Bitner.
Bitner believes any resistance to a cut in proc fees would be led by smaller, specialist brokers. “They may not have the capacity to increase the number of cases they process to compensate for any reduction in fees,” he says.
And he predicts proc fees will be cut as high street lenders become more flexible in the level of adverse credit they accept on standard products.
“This will force traditional impaired lenders to look at ways of reducing costs and improving competitiveness.”
Surprisingly some brokers, albeit from the major players, seem willing to lead the charge against higher sub-prime proc fees.
Ray Boulger, senior technical manager at Charcol, says there is scope to cut both standard procuration and packaging fees. “There is extra work if you do it properly but not enough to justify the higher fees,” he says. “BM Solutions and GMAC-RFC pay lower fees and clients gain from more competitive products. They certainly get most of our sub-prime business.”
And Boulger says packager fees also need cutting. “A much higher proportion of sub-prime cases go to packagers, making the total cost to the client significantly higher, up to 2%. I can't see how that can be justified,” he says.
Higher fees plus lack of transparency leave vulnerable clients open to abuse by unscrupulous brokers.
“Some lenders who are offering uncompetitive products are clearly getting business from somewhere,” says Boulger. “It would be naive to think that the level of fees they pay to brokers are not a factor.”
A quick glance at the back of the tabloids will show brokers advertising for sub-prime business with rates of up to 10% lurking in the small print. “Many borrowers with adverse credit pay over the odds because they worry too much about their mortgage arrears or CCJ, or they don't realise there are so many lenders competing for their business. Brokers can easily abuse that position, charging higher fees and selling inappropriate products such as single premium ASU,” he says.
Many brokers work in this market, but they aren't all reputable.
“Higher fees for sub-prime attracts a disproportionate number who are simply looking for what they can get out of it,” says Boulger. “They will simply find the best paying deal and make the client fit that, which doesn't involve any extra work at all.”
He hopes FSA regulation will clean up this murky corner of the market.
“We have seen some downward pressure on fees as the market becomes more transparent, especially with FSA monitoring of advertising. Currently, ads aren't monitored that closely. The Advertising Standards Authority or MCCB only take a look when somebody complains. But the FSA has said it will monitor adverts and hopefully will pick up those brokers charging 10% fees.”
But it won't just be overcharging brokers who fall foul of regulation.
Boulger says brokers and packagers who charge higher fees but fail to offer the best available products may no longer be able to get away with it.
And one further issue remains to be resolved. Currently, packagers and processing companies don't have to disclose the fees they get from lenders unless they have direct commercial links with the intermediary.
“We want clarification on whether that will change from October. Each lender is interpreting the rules differently. The FSA wants transparency but this will only come if everybody discloses things on the same basis. If they don't it will cause confusion and undermine what the FSA is trying to achieve.”
Lockhart Bruce, finance and marketing director with Opus Mortgages, says FSA regulation will inevitably lead to cuts in procuration fees for both brokers and packagers.
“If non-conforming lenders want to remain competitive they will have to compete on rate and criteria, and that means pushing origination costs down. I have no doubt they will do this by reducing the proc fee,” he says.
And Bruce acknowledges that the more detailed knowledge required for sub-prime business means that lenders will always pay a slightly higher fee for sub-prime business. “There is a huge difference in the sizes of fees paid but the FSA has told the industry that it believes a level playing field will ensure the customer gets a better all-round deal. It's only a matter of time.”
Opus is transforming itself from a packager into a specialist administration and processing organisation and a key part of this strategy is moving to fixed price processing fees.
“We have seen the writing on the wall for some time,” says Bruce. “Major changes to the way lenders pay intermediaries and companies like mine will come and the FSA will make sure this is sooner rather than later. That's why we spent the past 18 months adapting our business model.”
Bruce says moving to a flat administrative fee is common sense. “For standard non-conforming clients with a CCJ or those who simply want a self-certification mortgage, what extra processing is involved? In most cases, there is more work in prime business. Our fee structure reflects this.”
Colin Harris, senior product manager at BM Solutions, says it's important to differentiate between lenders and brokers who profit from overcharging borrowers and those whose charges reflect the higher workload and risk. The former are likely to resist any move to reduce fees but the latter have nothing to fear.
“Only those lenders who currently charge too much will see proc fees cut. It all comes down to fairness and risk,” says Harris. “BM Solutions' sub-prime products are transparent. We don't charge customers inflated rates or tie them in beyond the incentive period. Our rates are competitive and in line with the risk involved.”
Market forces are the main factor determining proc fees. “We brought transparency to the market by introducing mainstream choice and values,” adds Harris. “Before, products were confusing, and unscrupulous lenders exploited this to charge high rates of interest and pay inflated proc fees. The market is now close to equilibrium, with fees mostly reflecting work done by the intermediary. The days when unscrupulous lenders could overcharge the customer are over.”
Lender SPML has launched a technology project aimed at cutting paper-based documentation and the time introducers spend on each case. Stuart Aitken, director of credit, argues that technology will eventually reduce fees for brokers and packagers by cutting workload – but some will do better than others.
“Larger firms will be in a better position than smaller broker firms to invest in technology and benefit from more streamlined, automated packaging,” he says.
And Liz Walton, spokeswoman at First National Home Lending, says technology may improve lenders' systems but it can only do so much.
“We are still dealing with individual cases and this requires additional time and effort by underwriters compared with a high street application. Customers also require more skill, experience and time from the broker. This is reflected in fees.”
Market forces should ensure fairness in proc fees. “The increasing number of lenders in the non-standard market will ensure that proc fees remain competitive and represent the additional effort involved,” she says.
Alastair Pate, director of marketing at Kensington Mortgage Company, points out that many light adverse clients already pay only slightly more than prime mortgage clients. “We pay a maximum 0.5% for light adverse and 1% for heavy adverse. With lenders paying between 0.25% and 0.5% for standard business the difference may be marginal.”
He doubts this margin will narrow much further. “High street lenders are excluding more customers in a bid to reduce costs and this has fuelled the sub-prime market which charges a premium for risk. Market forces may force all proc fees down but it is unlikely the difference between prime and sub-prime will narrow further.”
Steve Jones, sales director at Towry Law Mortgages, says higher fees also reflect the fact that the average loan size in the sub-prime market is smaller. “People who have mismanaged their finances have tighter incomes, typically earning less than £30,000, which means they won't be able to borrow more than £100,000.”
Technology could speed a cut in rates in one respect, Jones says. “Credit reference agencies are now faster and more accurate. Lenders can assess risk quickly and make a decision without coming back for further information.”
If proc fees do fall, the big question is whether any cut will be passed on to clients in the form of lower interest rates.
“I don't think it will because it isn't the headline rate that pays the proc fee,” says Jones. “During the first couple of years lenders make little profit. Their margins come in the overhang period. Competition is forcing down headline rates but not underlying rates. Lenders can afford to lose 0.5% or 1% over a year or so, provided they get 2% or 3% in the overhang.”
Regulation, competition and technology seem likely to prove a triple whammy for those charging excessive sub-prime procuration fees although a slight differential should remain to reflect the extra workload. This all should feed through to more competitive products for the client. Otherwise, what's the point?