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Incentives are a big topic in complex systems that involve many middlemen. Where we talk about the complex process of buying a home and the abundance of middlemen in the form of third parties that hold a stake in the transaction in one form or another, we need to talk about incentives to understand why the home buying process ends up being messy.
Fundamentally, there is very little dictating why the home buying process ought to be the way that it is. While there are regulations set forth by different states and cities, the actual practices are a direct result of decades of capitalism (this being stated as a matter of fact, rather than taking a stance against or for capitalism in this scenario). What this means for you, the modern home buyer, is that the process that you’re being subjected to is a mixture of what ‘needs to be’ and what is ‘nice to have’ (with the distinction usually obfuscated).
For example, if you’re looking to finance a home, your lender will in some cases require you to adopt Private Mortgage Insurance (PMI). PMI isn’t a necessity as dictated by the state and isn’t inherent to the home buying process, but has become a market standard where generally if your down payment is <20%, you’d be required by your lender to purchase PMI to insure them against the chance of you defaulting on your monthly payments (the idea being that with a lower down payment, you are more likely to default on your mortgage).
Your lender will also require you to conduct a title search, and adopt a title lender’s policy from your title officer as a form of insurance. In this scenario as well, the title search and insurance processes as deemed necessary by your lender protect them in the scenario that you default on your mortgage – and they now seize your property, but run into problems with regards to ownership (we delve deeper into what PMI and the title processes are in our No Bullsh*t Guide to Closing Costs While Home Buying). While title search process does protect you from future disputes in ownership (and might be in your best interest to conduct one), and you can choose to adopt an owner’s policy to insure against this as well, it becomes a choice you can make for yourself in the case that you were financing the property with an all-cash offer.
In these scenarios, the title search & owner’s policy become a ‘nice to have’ if you’re financing the property through an all-cash offer, while the PMI and title search & lender’s policy become a ‘need to have’ in the case of a mortgage loan.
What you need is someone with your best interests at heart guiding you through what is ‘nice to have’ and what is ‘need to have’. While an individual agent can and should do this job well, in the scenario that they fail to achieve this, there is very little you can do about it. They will end up losing a referral from you if you end up realizing this (though you probably wouldn’t since you wouldn’t have any means of knowing otherwise) but apart from that, it would probably not affect their career in any practical manner.
While this inherently isn’t a problem, when you don’t have an entity strong enough backing you and your best interests, you can run into problems. Furthermore, even if you had an amazing agent, fighting a large law firm or a bank is out of the question for most home buyers and their agents – after all, there is very little that individuals can do against the market and its large corporations.
This is where the real estate agent’s brokerage should come into play. The brokerage is a large entity that hires the agent and in theory supposed to do everything in its power to ensure the success of the transaction (hence being a net positive for you to have on your side in the process). On one level, the brokerage should be directly responsible for the actions of an agent. On a larger scale, if a bank or a law firm is pulling shady tactics against you, the brokerage – which is hypothetically just as powerful as the other two entities – should step in on your behalf to fight for you, essentially acting as a big guard dog that you have on your side in the case of mishaps (of which there is no dearth of).
The problem with real estate brokerages is the way they make money (an exception to the rule of alignment of incentives/profits). While it would stand that a brokerage only makes money off of a successful transaction, how much a brokerage makes from every transaction is minimal (this usually ranges between 5% to 30% of the 3% the agent makes – essentially just a tiny fraction of the entire property value). They are running on razor thin margins, and in order to remain profitable, they tend to play the game of quantity over quality. The mindset is that if they hire thousands of agents, from whom they continue to make just a tiny portion of profits from each transaction, it should add up to a large enough sum to allow them to run their operations. We see this with every big name brokerage that you might recognize (such as Keller Williams, Compass and Realogy).
This is not only a huge disservice to individual agents (as previously mentioned in that super important but slightly tangential article we suggested you dive into), but also to the modern home buyer. When the only entity that you were supposed to have by your side that is large enough to fight for you if things go wrong on a scale that your agent cannot handle by themselves isn’t fulfilling its role, you’re kind of screwed – big time.
But you already knew that. You knew you were being screwed before you started reading this. That’s probably why you’re here in the first place. To understand why and how thoroughly you’re being screwed over, and if there’s any way to make the pain go away
We saw that there really wasn’t, and that’s why we decided to embark on the mission of making your life better for you – something that should have been done decades (arguably, centuries or even millennia) ago.
Buy your home today, the way you were meant to.
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