Understanding Real Estate Commissions: Who Pays?
When you set out to buy or sell a house, one factor worth considering is a real estate agent's fees. Unfortunately, most people are only interested in how much these fees are, and have no idea how they work or who even pays them once a transaction is complete. Here we take a look at some of the more universal principles of real estate fees.
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The commissions paid to real estate agents are negotiable and therefore they vary. Although many people believe that commission is always 6%, a 2004 report by REAL Trends Data showed the average commission rate in the U.S. to be 5.1%. That percentage is a percentage of the sale price of the home, so the exact amount this will entail will not be known until an offer has been accepted and the house is sold. Any commission to a real estate agent must be negotiated as part of the contract between the agent and the buyer or seller before the deal is completed. (For related reading, see 5 Ways To Save On Real Estate Fees.)
Precisely who pays a real estate agent's commission is where things get a little tricky. Assuming that both the buyer and seller have an agent, you could argue that the seller pays it or that the buyer pays it. This is because the fee comes from the proceeds of the sale and is often - although not always - split evenly between the two agents.
For example, suppose that a buyer and seller (each with a real estate agent) agree to a deal on a home. The home is sold to the buyer for $250,000. Assuming the real estate commission is 6%, this means that the commission due on this sale is $15,000. You could either argue that the buyer is paying this fee (because he or she is paying the cost of the house), or that the seller is paying it (because it is coming out of the home's equity). Either way, it is important to note that this fee comes out of the cost of the home - it is not tacked on in addition to the sale price. So, if the seller owns the house outright, he or she will emerge from the sale with $235,000 ($250,000 - $15,000).
How Is the Money Distributed?
The contracts the buyer and seller have with their agents determine the fee each agent will receive ahead of time. The percentage rate is often split evenly between the buyer's and the seller's agent, although sometimes a contract can stipulate that one agent will receive more of the commission than the other. Then, it is generally up to the lawyers in the transaction to extract the commission and distribute it according to the agents' contracts. However, the fee doesn't go straight to the real estate agents - it goes to their brokers. Licensed real estate agents must work for a broker, many of which take a cut of the real estate fees to cover the cost of things such as advertising, signage rental and office space.
Contentions About Real Estate Fees
One of the biggest contentions about real estate fees is that they are too high, or that the service real estate agents deliver isn't worth the cost of the fees. While there are certainly both good and bad agents, this is a still tough argument to win on either side. For example, suppose the home in the example above sold on the first day it was listed. This does in fact mean that at least the seller's agent makes $7,500 for a relatively small amount of work - mostly taking photos, listing the home, discussing pricing with the seller and answering his or her questions. However, on the flip side, a home can also take weeks, months or, in the case of very unique or expensive houses, years to sell. For the seller's agent, this can add up to many hours spent marketing the home, holding open houses and taking phone calls and staying abreast of other listings and sales in the neighborhood; that agent will also bear the long-term cost of keeping the house on the market, including signage and advertising fees. If you look at it this way, not many sellers would want to take the risk of paying a real estate agent by the hour.
The same goes for buyers - some will find a house immediately, while others will look at dozens of homes before settling on one. If buyers had to pay an agent by the hour, they would have the disadvantage of being rushed. If they were to pay the agent a flat fee, this could put the real estate agent into a position to move the choice along more quickly. In this way, the commission system is designed to act as a sort of compromise between buyer and seller.
That said, there are listing agents who work for a flat fee. This can obviously benefit sellers in terms of cost savings, but the drawback is that these agents generally offer limited representation. In a sense, percentage-based real estate fees act as a type of insurance that protects both the real estate agents and the buyers and sellers they represent. As with insurance, only one party gets maximal benefit in each particular case, but this balances out to keep the system working. (For related reading, check out The Lowdown On Low-Fee Real Estate Agents.)
In cases where the real estate agent must work many months to complete a deal, the percentage fee ensures he or she can expect a reasonable sum for the work completed and expenses incurred to get the job done. However, this also means that a real estate agent will sometimes get paid just as much for much less work. Because both parties enter into the transaction without any knowledge of the outcome, the rate is seen as a fair way to ensure that the buyer or seller doesn't pay too much, and that the real estate agent is fairly paid for the amount of work the deal may entail. A percentage is also a way to level the playing field in terms of making real estate agents available to buyers and sellers whether they are millionaires or are looking to buy or sell a $90,000 condo. (Do you have a good real estate agent? Read Top 5 Signs Of A Bad Real Estate Agent for some clues.)
The Bottom Line
Real estate agent commissions may be one of the least understood aspects to buying or selling a home. If you decide to recruit the services of a real estate agent, make sure you read the contract carefully and understand the terms regarding the commission you will pay for your agent's services.