Rating the non-banks

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I'm often asked by budding home owners "Are non-banks better than banks?"

By non-banks they don't mean building societies or credit unions - homebuyers these days are fairly confident about approaching them for a home loan (they write about 7% of all mortgage business).

But they are not confident when it comes to lenders who act as suppliers of loans but cannot take deposits.

These non-banks are writing about 3% of mortgage business, compared with 13% before the global financial crisis (GFC).

Lenders such as State Custodians, Mortgage House, Rate Busters, Collins Home Loans and even Pacific Mortgage Group, which recently won Money's Best of the Best Cheapest Home Loan award, usually all pop up on online comparison sites as the cheapest, but how good are they?

The answer isn't that easy. Stating the obvious first, such non-bank home loans are generally cheaper than the major banks or even building societies or credit unions.

On average a loan from a non-bank is around 0.5% cheaper than the average standard variable rate from the big four banks. On a $300,000 mortgage over 30 years, that's a difference of over $100 a month in repayments.

Most home owners who take out a mortgage with a major bank are eligible for a discount of up to 0.7% off the standard rate, but a fee of around $400 a year applies.

Some not so obvious issues face non-bank home loan customers. Exit fees are far more expensive with a non-bank. This may not seem a concern, given all exit fees on new home loans from July 1, 2011 will be abolished under the federal government's Banking Reform package (designed to boost competition), but what impact will this have on non-bank competitiveness?

The CEO of the Mortgage and Finance Association of Australia, Phil Naylor, has gone on record saying "the banning of exit fees will have the reverse effect [and decrease competition] by causing non-banks to lose their most effective weapon in competing with banks, the deferred establishment fee". Non-banks figured that because they didn't charge an upfront fee and in general charged a considerably lower interest rate than the majors' standard rate, they were entitled to charge a "deferred establishment" fee if a borrower left within three to five years.

The question now is: with exit fees abolished, will non-banks be forced to raise their upfront fees? And with exit fees abolished, can they continue to sell portfolios of securitised mortgages without them?

You see, investors who provide the capital for non-banks to on-lend expect a stream of future cash flows. Exit fees deter borrowers from leaving early. Get rid of them and non-banks would have to cover the shortfall - a situation that could cost them their price competitiveness.

Now for another issue. At the moment most non-banks often cite no establishment fees, yet speak to a mortgage broker or a customer that has gone through a non-bank to secure their finance and you soon realise that plenty of them will charge you legal fees, document handling fees, settlement fees and so on. While these fees may not be picked up directly by non-banks, as they often outsource them, they can still apply.

So while the non-bank may not directly charge you these fees, it's in your interest to clarify whether they are applicable. At the end of the day, it's still money out of your pocket regardless who's charging.

Finally, there are the lessons learned from some less fortunate non-bank customers during the GFC. During the crisis Money received emails from non-bank home loan customers whose variable interest rate kept going up outside official rate hikes, yet their lenders were advertising variable rates for new loans that were still cheaper.

"It comes down to non-banks obtaining funding from several channels at different times," says Canstar Cannex's mortgage specialist Mitchell Watson.

For example, three borrowers at the one non-bank lender may have two different "funders", which means there is potential for their rates to move independently.

Because they're funded from different parties they can have different conditions and rates although labelled by one lender.

Non-banks can suit people who are price buyers but they don't provide a full banking experience. If there is transparency, you understand and accept the conditions, and there is service to support your needs, they can be a good alternative.

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Effie Zahos is editor-at-large at Canstar and a financial commentator. She is the author of A Real Girl's Guide to Money: From Converse to Louboutins, and a regular money commentator on TV and radio across Australia. In 1999, a background in banking Effie helped kickstart Money, which she edited until 2019. Effie holds a Bachelor's degree in economics.