At the first public hearing of the Productivity Commission’s inquiry into competition in the Australian financial system in Sydney on Wednesday (28 February), the commission highlighted that it was considering asking the government to require all lenders to offer home loan customers refunds for the cost of lenders mortgage insurance (LMI) when customers choose to refinance or pay out their loan.
In the draft report, which was released earlier this month, the commission highlighted that LMI can help borrowers with “poorer credit ratings” obtain a home loan and help smaller lenders manage their risks.
According to the commission, approximately 23 per cent of owner-occupier loans are supported by LMI, but it argued that those who capitalise the value of LMI fees into their loan and switch providers while remaining over the 80 per cent loan-to-value threshold should be offered “refundable premiums” that could reduce the cost of switching.
Speaking to The Adviser at the public hearing, the CEO of CHOICE went further and called for an abolition of the insurance.
Alan Kirkland said: “We were struck by the number of borrowers who are subject to LMI. Less than a quarter of first-time borrowers are subject to this, but it too is an opaque market. It’s an extremely opaque market. So, on the one hand, you have lots of borrowers subject to it, and on the other hand, you have very few suppliers and two of them are owned by major banks. So, that says to us there is something wrong… And it’s very hard to justify the existence of LMI in its current form.”
The CHOICE CEO said that the abolition of the insurance is justified as it “is not insurance that provides any value to the consumer; it provides value to the lender by ensuring them for the risk of default”.
He argued that riskier borrowers are being penalised by the banks, as they “are already paying some interest rate premium”.
Mr Kikland elaborated: “People who have a higher loan-to-value ratio (LVR) are more likely to pay higher interest rate to start with. And those with a higher LVR are required to pay for this product. Yet, they have no ability to exercise choice and it returns no value to them and it further adds to the complexity of decision between providers. Because, alongside having to consider the interest rate, any fees and charges, the impacts of bundling other products in, you then [also] have to compare the cost of LMI required to pay.
“So, it actually adds to the complexity of the comparison task, and a further complication is that consumers don’t understand what LMI is.”
Therefore, the CEO added: “Far from allowing it to be refunded, which would provide some improvement on arrangement, we would instead argue for an abolition of LMI.
“We think that the extent that some borrowers represent extra risks, then that risk should be priced into the loan so that the price is more transparent, it’s much easier for borrowers to compare products, and if lenders feel (or for prudential reasons they need to insure for that risk) there is nothing to stop that from continuing to do that.
“We just shouldn’t dress it up as a product that is being sold to consumers because it’s clearly not.”
However, the CHOICE CEO cautioned that he was not “suggesting consumers would pay more under this system”. Instead, he was saying that consumers would be paying less as they would not be charged multiple times for being higher risk.
He said: “Consumers… are already paying now because they are being required to pay LMI and then they are paying interest on top of that (because in many cases, they then add to it to the value of the loan).
“So, if you look at what happens through the process, you have some banks who are right through the process making money. Making money from running mortgage broking business, then making money from mortgage itself, then making money from the LMI business that they own and then they are making money from the interest on the LMI… that is an incredibly opaque set of arrangements for a consumer to understand and build into their decisions about which product or which lender to go with, and I think it is one of the factors that works against competition in this market.”
Productivity Commission chair Peter Harris said that while it was “not so much a problem that [banks] are mak[ing] money off any of these processes”, the concern was more over “whether the parties paying are aware they are paying or if they are aware that they have a choice”.
In response, the advocacy group CEO said: “From a competition perspective, it is the fact that the person who is paying for this relatively expensive product actually has no control over the decisions, so there is no incentive to reduce price or value to the consumer.”
He concluded: “It is incredibly [hard] to explain why LMI operates in the way it does now because it just doesn’t make sense. The only reason I can give is because it is the simplest and most convenient arrangement for banks and that they profit quite handsomely for it.”
The Productivity Commission will host another round of public hearings in Sydney today (1 March) and in Melbourne on 5 and 6 March.
The final report is expected to be handed to the Australian government by 1 July 2018.
Annie Kane is the editor of The Adviser and Mortgage Business.
As well as writing about the Australian broking industry, the mortgage market, financial regulation, fintechs and the wider lending landscape – Annie is also the host of the Elite Broker and In Focus podcasts and The Adviser Live webcasts.