Your Home Equity and Real Estate Commissions

Wednesday, 26 February 2014

If you're like most people, your home is the biggest single investment you've got. You expect it to increase in value over time, and you probably have more money tied up in it than in any other investment. This money is your equity, and a large chunk of it disappears when you sell your home using a real estate agent.

In this article, you'll learn how real estate commissions affect your equity, you'll see just how many real estate agents make money from a single commission, and in the section called Avoiding the Pressure, you'll get an inside look at why many real estate agents are so persistent at getting their sellers to accept low-price offers.

A Quick Word to Buyers

Buyers and sellers alike benefit when there is no real estate agent involved. The term "fair market value" has a different ring to it when the middleperson is taken out of the equation, and prices trend to a truer value when they no longer reflect real estate commissions.

Equity

Equity is the value of the unencumbered interest in your home. It's the difference between the fair market value of your home and the unpaid balance of your mortgage, plus any other outstanding debt on the home.

Real Estate Commissions

Real estate commissions are the fees earned by real estate agents and are based on the selling price of the property. They're usually in the range of 6%, and they represent an excessive portion of the property's equity, equaling thousands and thousands of dollars.

Your equity increases in two ways: as you pay off your mortgage and as your home appreciates. It decreases when you borrow against your home. But nothing reduces your equity quite like a real estate commission. You get nothing for it that you couldn't have got on your own.

Here are three assertions for why you should sell your home yourself:

Lower Cost of Selling

If you sell your home using a real estate agent, the commission you'll be charged is around 6%. For a $250,000 home, that's $15,000. For a $600,000 home, it's $36,000. You have to ask yourself what you're getting for all that money. The cost of selling your home on your own is negligible by comparison, and the result is the same: your home will sell. If you list your home on a For Sale By Owner real estate wed site, run a few classified ads in the real estate section of your local paper and prominently display a For Sale By Owner sign in your front yard, the cost of selling your home could be less than $1,000. With the amount you'd save in commissions, you could still afford to advertise more, if necessary, in places like local real estate publications and newspaper supplements.

Retaining Your Equity

Let's say a couple decides to sell their home. It has a fair market value of $300,000 and they have $60,000 of equity in the home. They decide to use a real estate agent and agree to pay a 6% commission, or $18,000. The house sells. After the closing, the couple realizes they've lost 30% of their equity. The $18,000 commission paid at closing meant that instead of walking away with $60,000, they only walked away with $42,000. So they have much less to put down on their next home.

Avoiding the Pressure

The economist Stephen D. Levitt and co-author Stephen J. Dubner wrote recently in their book Freakonomics (HarperCollins Publishers, Inc.) of Levitt's study showing that when real estate agents sell their own homes, those homes stay on the market an average of 10 days longer than their clients' homes. The same study shows that the selling price of real estate agents' homes is on average 3% greater than that of their clients.

Here's why. A couple who lists their home with a real estate agent for $250,000 may hear from the agent that someone has offered $240,000 for the home. The agent will typically insist that this is a good offer and that the sellers should take it. Why would the real estate agent be so eager to accept a price that's $10,000 below the seller's asking price?

It's simple. Agents split their commissions: half goes to the buyer's agent, half to the seller's agent. Then it's usually split again: each agent gives half of their commission to the agency they work for. So the agent representing the seller is only getting 1.5% of the sales price of the home (6% ÷ 4).
With a $240,000 offer, the price of the home is reduced by $10,000, but the commission is reduced by only $600. The real estate agent's cut of this is $150. It will cost the seller's agent only $150 to accept the low-price offer. What does it cost the seller? An additional $9,400.

This situation happens every day. There is a strong incentive for real estate agents representing the seller to entice their sellers into accepting offers well below their asking price.

Summary

As you can see, there are tremendous financial advantages to selling your home yourself. That's not to say it's for everyone. It requires a little more effort, and some are willing to part with all that equity to have a real estate agent do it.
But selling your home yourself can be easier than you think. The right research will help you price your home correctly, understand the paperwork involved, and prepare you getting the home ready to sell.

Make sure you walk away from your closing with your equity intact.