The federal government's plan to ban exit fees, although designed to help consumers, will have the opposite effect as it stifles bank competition, according to the mortgage and finance industry in Australia.

Following the Government's draft release on the banning of planned exit fees, the Mortgage and Finance Association of Australia (MFAA) has called for the government to abandon the ill-conceived plan.

The introduction of exit fees in 1996 by Aussie Home Loans saw increased competition, reduced interest rates, product development, and increased access to finance for all Australians, MFAA said. Those benefits have been dramatically demonstrated by the resilience of the Australian housing market and Australian mortgage backed bonds throughout the GFC.

"This good work will be undone out of a misguided and ill-informed initiative designed to help consumers, but which will have the opposite effect."

The ban on exit fees strikes at the basic Australian principle of fair play - of user pays. It is self-evident that there is a cost in switching loans, and so those who rort the system by switching regularly will be supported by the vast majority who don't. The result will be higher interest rates for all.

Worst still, if exit fees are banned, borrowing will become harder, particularly for first home buyers and those with small deposits because costs previously carried by lenders will need to be charged upfront. This means bigger deposits for all, and makes homes even more unaffordable for Australians.

MFAA chief executive Phil Naylor, today said "It had to happen sooner or later. The rate of Credit Reform in Australia has had its first casualty - freedom of choice for borrowers".

"If exit fees are prohibited, balance sheet lenders can simply dive into their very deep pockets and wait until their competitors exit because they have run out of funds. Then when competition is reduced, the lenders left standing can put rates up again".

The banning of exit fees will also reduce product flexibility. It is likely that honeymoon interest rates, lenders paying mortgage insurance and establishment costs, loyalty interest rates, and many other flexible loan features will disappear.

"Such a major change to the law should be put through both houses of parliament rather than be snuck through by regulation", Naylor continued. "The opposition and some independents have already expressed their opposition to the move, but are being denied the opportunity to vote against it.

"Nobody has advanced one good reason for banning exit fees, and so this initiative is playing on cheap headlines without understanding how the mortgage industry works. ASIC recently reviewed the use of exit fees and issued guidance to ensure that consumers can't be ripped off by them.

"What the government is doing now is lunacy - catching a quick 10 second grab (banning exit fees sounds good at first glance) - at the expense of the Australian public."