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Sydney Morning Herald
Wednesday March 6, 2002
The growth of the non-conforming segment of the mortgage market has generated a few bugs. Christine Long reports.
The emergence of non-conforming lenders in the mortgage market is a positive development for borrowers with atypical credit histories, particularly at a time when casualisation of the workforce is so widespread. But borrowers should nevertheless be careful that they are not taken advantage of by unscrupulous players.
The experience of sharp practices overseas has prompted some of the bigger lenders in Australia to take steps to ensure such practices do not gain currency here.
There are now four major non-conforming lenders in the Australian market Bluestone, Pepper Home Loans, Liberty and GE Mortgage Solutions offering finance to people with poor credit histories, such as the self-employed, recent divorcees, migrants, older borrowers and those who have been bankrupted in the past.
As Richard Klemmer, chief executive of Pepper Home Loans, says, they offer a lower cost alternative to solicitors' mortgages or finance companies for borrowers who don't fit the ``cookie cutter mould".
Currently such loans represent about 1-2 per cent of the $100 billion Australian mortgage market and are mostly sold by brokers. But their stake is likely to grow in line with changing work patterns.
However, potential borrowers do need to be aware that these loans come at a price. Bob Holmes, lending support manager at the mortgage broker Smartline Home Loans, says they are usually more expensive than traditional loans, reflecting the extra risk being taken by the lender.
Interest rates can be several percentage points higher than those charged by traditional lenders, ranging from about seven per cent to 13 per cent.
Establishment fees are also typically higher than usual, Holmes warns. Pepper, for instance, charges a settlement fee of about 1 per cent of the loan advanced. So someone with a $200,000 loan would pay $2,000.
This is compared with a prime lender where the establishment fee is usually about $600 including valuation and legal fees, says Holmes.
Borrowers who choose to refinance early can also face penalties in the form of a flat fee, a percentage of the loan value, or a number of months' interest.
Bluestone, for example, charges a sliding scale of ``deferred establishment fees" if someone refinances within the first three years of the loan. These start at 4 per cent of the amount repaid in year one and drop to 2 per cent of the amount repaid by year three.
Holmes says borrowers should also be aware of the level of commissions that non-conforming lenders are paying to brokers on these loans.
In overseas markets there has been a trend for brokers to steer people into products with higher commissions, called adverse steering (see breakout).
While a prime lender in Australia may pay a broker a 0.6 per cent upfront commission along with 0.25 per cent ongoing, the commissions paid by non-conforming lenders can be significantly more.
Liberty, for instance, allows brokers to choose the level of commission they wish to receive. Under its arrangement brokers are offered the choice of setting both upfront and ongoing commissions anywhere between zero and 1 per cent.
So, in theory, it is possible to take total commissions of 2 per cent within the first year. Sherman Ma, managing director of Liberty, says in practice brokers rarely decide to take the maximum level of both ongoing and upfront commission and any commission taken would be disclosed to the borrower in dollar terms in the loan documents.
However, the difference in practices highlights the need to shop around before taking out one of these mortgages.
Alistair Jeffery, chief executive of Bluestone Mortgages, says he has seen one instance where a broker was proposing to charge an upfront fee of 8 per cent or $16,000 on top of an interest rate of 13 per cent on a $200,000 mortgage.
To avoid such situations he suggests using a broker who has access to more than one non-conforming product and checking that you are not paying a fee for service on top of commissions. Also ask whether the commission is discretionary.
Finally, Holmes says consumers should consider a non-conforming product only if they have been knocked back by one or two of the traditional lenders.
Dirty dealings in Britain, US
Because the non-conforming market caters to people who have few alternatives, it can give rise to some questionable practices.
Alistair Jeffery, chief executive of Bluestone Mortgages, explains that in Britain and the US these included charging high upfront fees, brokers adding 1 per cent or more to the interest rate paid by the borrower without telling them, and tied relationships between brokers and lenders that were not transparent to the borrower. As one lender reports, brokers were steering customers too often towards the loan that paid the highest commission rather than the best one for their circumstances. To prevent similar practices from becoming a feature of the Australian market, a sub-committee of non-conforming lenders was formed recently at the Mortgage Industry Association of Australasia (MIAA). It will review the association's code of practice to decide whether it should offer any extra protection to consumers taking out non-conforming loans. The NSW president, Peter Beverley, says the MIAA is keen to adopt best practice upfront to avoid a crack-down by local regulators. CL
© 2002 Sydney Morning Herald