The proposed settlement between the National Association of REALTORS (NAR) and class-action litigants has prompted much discussion about a series of practice changes affecting compensation for real estate professionals. Despite bipartisan agreement that supply shortages are driving housing’s unaffordability issue, some point to commissions. As a salve, a vocal minority of activists say that “simply” allowing the financing of buyer-agent commissions into mortgages will resolve all concerns. As an economist focused on the real estate market for years, I’m wary of ideas that sound too good to be true. This claim is misguided, oversimplifying a more complicated reality.
For reasons both practical and legal, buyer-agent commissions are not today explicitly financeable with a mortgage. For loans backed by Federal Housing Administration (FHA), it is a matter of law. For mortgages backed by Freddie Mac and Fannie Mae (the GSEs) or the Department of Veterans Affairs (VA), it is a matter of policy.
Some advocates are urging “simple” changes to allow mortgage financing of commissions to benefit homebuyers unable to pay a buyer’s agent commission out of pocket. But this is much easier said than done. To do this, the GSEs would have to change their policies and get the approval of regulators. Likewise, for FHA loans, you’d need to pass an Act of Congress, while Veterans would need to convince the Secretary of Veterans Affairs that a change is in the best interest of veterans, taxpayers, and investors.
But let’s suppose all that occurs. What, then, would be the benefit to potential homebuyers? Would it be worth the effort? The answer is that there are no new benefits if you explicitly include buyer agent commissions in mortgages. If buyers pay the commission out of pocket (which is already allowed), they will have less cash remaining for their down payment. This would lead to less favorable terms for buyers because they would face a higher loan-to-value ratio (LTV). And if they instead explicitly roll the commission into the loan balance but put all their cash towards the downpayment, the results would be effectively the same! Either way, the resulting LTV on the buyer’s mortgage is the same—less positive for buyers.
Less Cash, More Problems
This is an important implication. Mortgage loans and mortgage insurance are priced based on characteristics of the loan, including borrower credit score and LTV—and for higher LTV loans, the combination of these fees means higher monthly payments. In fact, these suggested solutions would either result in higher interest rates and higher mortgage insurance premiums for the life of the loan or—even worse—make the borrower ineligible for financing because of current rules about maximum LTV thresholds.
To avoid this, you’d need additional rule changes. But should we lobby for looser underwriting standards to accommodate commissions for very high LTV borrowers? We learned from the Global Financial Crisis that when 100% financing becomes more common, the threat of foreclosure becomes all too real. It’s a bad idea.
Alternatively, some of these advocates think the GSEs, FHA, or VA should simply allow the inclusion of the commissions in the mortgage amount but not as part of the LTV calculation. Thus, a 97% LTV would not be adjusted to reflect the actual 98%, 99%, or over 100% LTV with the commission added. It’s another bad idea, but not without precedent.
In fact, it would be similar to what is known as a rate buyup – when the borrower finances their closing costs in exchange for a higher rate. Based on historical pricing, this “quick fix” would result in an interest rate that was at least 0.25% higher for every 1% of agent commission financed by the buyer. Buyers can do this today without a change in policy by agreeing to a higher mortgage rate in exchange for cash upfront to pay their closing costs. By putting the remainder of their cash towards their agent’s commission and the downpayment, the solution is feasible but more expensive.
Buyers end up paying materially less in interest and mortgage insurance premiums if the listing agent agrees to pay the buyer agent commission (as has customarily been the case). Under the settlement, sellers can still compensate the buyer’s agent. Furthermore, the buyer will end up paying materially less in interest and mortgage insurance premiums than if the buyer pays the commission out of pocket and finances the commission. Importantly, the GSEs and the FHA published industry letters in April 2024 advising lenders that, as long as the practice of sellers compensating buyers’ brokers remains the local custom, it is acceptable without additional financing costs to the homebuyer or other restrictions!
The custom of the seller paying the buyer agent’s commission evolved out of efficiency gains. I admit it is not the structure that is obvious if one were designing the market from scratch. Yet, it has tremendous benefits for homebuyers and sellers. The U.S. housing and mortgage markets are in an equilibrium based on historical norms, reliably quantifiable risks, and a global, highly liquid market for GSE and Ginnie Mae mortgage-backed securities. These efficiencies allow American consumers to enjoy the lowest cost home financing, with the best terms, among all mortgage borrowers in the world.
The purported benefit to consumers from financing commissions already exists through smaller down payments. Moreover, the changes the activists envision would cost homebuyers, and potentially sellers, more than if current practices remain standing. Faced with a gaping supply shortage and high mortgage rates, the last thing buyers need is another hurdle.
Amy Crews Cutts is the President and Chief Economist at AC Cutts & Associates LLC.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
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