The emergence of procuration fees can be traced back, along with the advent of mortgage packaging companies, to the break-up of the mortgage cartel that existed until the early 1980s.
In essence, procuration fees are paid by lenders to enable intermediaries, and mortgage distribution and packag.ing companies, to efficiently distribute their mortgage products.
Today, the most noticeable feature of procuration fees is that they differ according to niche area. Lenders, for example, will pay higher procuration fees for sub-prime and specialist (such as self-certification and buy to let) products than for prime products.
Procuration fees payable on prime business are lower in part due to the fact that these types of products are readily available from high street lenders that tend to market and distribute these types of mortgage products themselves directly to the general public. Other contributing factors include the competitive nature of prime mortgage business and the lower margins on these types of products.
Lenders pay a higher commission on sub-prime and specialist mortgage products because cases tend to be more complex and time-consuming, requiring extra work from the broker. A more realistic explanation is the fact that margins on sub-prime and specialist products are higher and therefore procuration fees are higher as a consequence.
Many lenders distribute a high proportion, and in some instances, all of their lending through the intermediary mortgage market. Mortgage packaging and distribution companies are also involved in the process of paying procuration fees, providing distribution services to both lenders and intermediaries. In this context, procuration fees constitute an integral part of the mortgage distribution process.
The vital link
Mortgage distribution companies in certain circumstances also enable intermediaries to earn higher procuration fees than would be payable by going directly to the lender.
The current trend in the mortgage market is an increased focus on customer retention and cost reduction.
For example, increased use of online technology and online applications will reduce mortgage distribution costs for lenders as intermediaries will increasingly put more cases onto the lenders’ systems via the internet. The advent of secure electronic signatures could increase this even further.
This could be a reason to pay the intermediary a higher procuration fee as he will be doing more of the lenders work and will play an important part in the cost-reduction process.
However, as consumers become more financially aware and begin to embrace e-trading in larger numbers, lenders will no doubt pursue these cheaper channels to market. We have already seen an increase in telephone and direct mail sales ‘ and the internet will add to this pressure.
Alternatively, trends in the niches, such as sub-prime, point to a potential reduction in procuration fees.
The current trend is to give sub-prime borrowers a better and more competitive deal. This could lead to a reduction in the procuration fee payable to the broker. For example, the standard procuration fee for sub-prime business is usually 1%, with some sub-prime lenders paying up to 2%. However, the sub-prime market is undergoing significant change and as more lenders enter the arena the result will mean more competitive products, lower rates and perhaps lower procuration fees. An indication of this can already be seen with rates on adverse products falling and some lenders, new to the market, offering broker commissions of 0.5% on sub-prime deals. What remains to be seen however, is if this forces traditional sub-prime lenders to follow suit.
The role of the intermediary in terms of mortgage distribution is crucial. According to research conducted by the Council of Mortgage Lenders (CML), customers still want face-to-face contact when making such a large-scale financial commitment. Many new entrants to the industry are reassessing their need for a high street presence and targeting intermediaries for new business, as this is seen as a cost-effective way to distribute mortgages.
A reduction in procuration fees may initially benefit borrowers, but lenders will run the risk of possibly damaging a sector of the market by reducing the number and quality of financial intermediaries that provide them with the market share they currently enjoy. This may then lead the intermediary to look at other ways of generating income.
In light of the recent consultation papers issued by the Treasury and the changes to the financial services sector there has been much debate about intermediaries who wish to be labelled truly independent turning to fee charging rather than receiving commission.
If the long-term intention is for all independent mortgage intermediaries to be advice fee-based, then the whole of the payment structure would need to be totally overhauled. Currently, the lender pays the procuration fee to the intermediary, via a mortgage distributor or directly, and the borrower benefits from free professional advice. If the borrower were to pay for professional advice the intermediary would not necessarily receive broker commission and the lender could channel this money into more competitive products.
Procuration fees constitute a major part of the mortgage distribution process and enable lenders to reduce their own costs. The trend is for more competitive products available to the public via intermediary channels so it is unlikely that turning to fee charging would actually benefit the customer.
Lenders may look at alternatives to traditional proc fees such as trail fees in an attempt to stem remortgaging.
Trail commission is a form of procuration fee where the lender pays a smaller broker fee up-front upon purchase. Subsequent smaller commissions are then paid at periodic intervals through the lifetime of the loan.
The mortgage market is currently extremely buoyant and competitive. Continuing economic growth, low unemployment and falling interest rates have all led to an increased demand for housing and mortgages. According to the CML’s annual report published in May, mortgage lending reached record levels in 2001. Gross advances rose by 34% to £161bn, and net lending increased by 32% to £55bn.
This has inevitably led to an increase in remortgage business. Borrowers are taking advantage of low interest rates and increased competition to remortgage to a more attractive rate and product. According to the figures in the April CML/DTLR survey of mortgage lenders based on mortgage completions from both banks and building societies, remortgaging reached a record level of £6.1bn in March 2002.
In this climate, it is doubtful that introducing trail commission to remortgage products would realistically stem remortgage business. Instead, lenders are looking at alternatives to retain mortgage customers. Current account and offset mortgages are a prime example of this. Borrowers are being offered a mortgage along with current accounts, overdraft facilities, loans and savings facilities.
The development of new mortgage products by new entrants into the mortgage market and investment into initiatives to acquire and retain customers will be used to discourage the borrower from remortgaging away from their current lender, rather than the increased use of trail commission.
Procuration fees are an integral part of the mortgage distribution process. The intermediary is performing a level of distribution and information dissemination to the client and is paid a broker commission in return.
If regulation results in a smaller number of intermediaries this could result in those remaining becoming more valuable and thus being able to procure higher commissions. Conversely this may also have the effect of lenders pursuing other channels to market.
Market trends such as increased use of technology via intermediary channels to maximise distribution and reduced costs may result in higher procuration fees. On the other hand, the introduction of more competitive products and new lenders within the sub-prime arena may have the opposite effect and reduce procuration fees.
To conclude, the overall cost to the lender will ultimately dictate how mortgage products are distributed. With new channels of distribution such as the internet, telephone and direct mail becoming increasingly more popular and more effective, we can expect lenders to pursue these channels more vigorously.
While the intermediary remains in a strong position as they influence such a large share of the market, and will always be able to offer face-to-face contact and professional advice, one cannot rule out reductions in procuration fees in the longer term.
David Copland is sales and marketing director at Pink Home Loans
Cost savings that result from online processing may be passed onto brokers in the form of higher commissions.
Pricing pressure may cause fees to fall in niche areas.
In the current economic climate trail fees are unlikely to stem remortgaging.