Einstein is wrongly credited with a very correct quote on compound interest, where it is referred to as the eighth wonder of the world. Those who understand it, earn it, while those who do not, have to pay it, so the saying goes.
The intersection between personal finance and real estate ownership has been an obsession of mine for the better part of a decade.
In real estate, the right agent will make you thousands - even millions of dollars, while the wrong one will do exactly the opposite. And it happens through compound interest.
Compound Interest
Interest can be simple or compounded. Simple interest is the type of interest you’d charge a friend or family member on a loan. It is only calculated on the amount borrowed. If a family member borrows $1,000 from you and you charge them a 5% interest rate, odds are if the loan is out for 5 years, you will collect a simple $250 in interest plus the original $1,000 principal amount.
Compound interest takes into account both the initial principal and the accumulated interest. Unlike the previous example, interest compounded in this situation looks like this:
Year | Principal | Interest | Total Owed |
1 | $1,000 | $50 | $1,050 |
2 | $1,050 | $52.50 | $1,102.50 |
3 | $1,102.50 | $55.13 | $1,157.63 |
4 | $1,157.63 | $57.88 | $1,215.51 |
5 | $1,215.51 | $60.78 | $1,276.29 |
So instead of your family member owing you $250, they owe you $276.29, a 10% increase. You can imagine how much they’d owe in the case where their loan is outstanding in 30 years! We’ll get to that in a moment…
But first, should you have an agent in the first place? Agents get a lot of flack for being useless, and by and large, this is true. Anyone with a pulse and some intellect can get a real estate license, but real estate school teaches you nothing about how to be an exceptional agent. Becoming a valuable real estate agent requires a deep, long-term commitment.
Buyer Real Estate Agent
You should always use a real estate agent to buy a home, if for no other reason than because it is free. That’s because when a home is sold, the commission is paid by the seller to the listing agent, and the listing agent then splits it with the buyer’s agent.
There are some circumstances where a buyer may owe a commission, but it is very rare as of February 2024. Your agent will talk through any nuances as they arise.
As I point out in my free first-time homebuyer ebook, the right buyer’s agent will help you find a good deal, understand the market, and most importantly, will negotiate with listing agents on your behalf.
Seller Real Estate Agent
The question of using an agent to sell your home is more nuanced than the case of buying. Selling a home with a licensed real estate agent can cost between 4-6% of the sales price. On a $500k home, that shakes out to $20-30,000. Obviously a big chunk of money.
Sell the home yourself (“For Sale by Owner”, or “FSBO”) and you can pocket all this money instead, right? Wrong.
A good seller agent is going to sell your home for far more than you think you could. But don’t just take my word for it. The National Association of Realtors, with their treasure trove of real estate data, noted in a report that in 2023 the median FSBO sold for $310,000 while homes that used a real estate agent sold for $405,000. That is a $95,000 difference. Of course, these figures are influenced by a number of variables, but even if the difference is within 20% of the $95k number, it is still well worth the commission paid to an agent.
The Right Agent
The right agent will end up saving you/making you thousands, if not millions of dollars when you go to buy or sell a home. It ties back to compound interest.
Who is the right agent? The right agent is someone who first and foremost appreciates the value of a dollar, is willing to fight for your dollars, and understands that deals are made on price AND terms, instead of just price.
Right Agent | Wrong Agent |
Understands the cost of fixing things and will point out older capex | Minimal ownership experience and minimal experience fixing things |
Understands and fully appreciates the value of money | Does not appreciate the value of money |
Understands the macro and micro markets | Does not understand nor distinguish between the macro and micro markets |
Understands what's important to the sellers | Thinks price is the only thing |
The right agent will optimize your purchase and your sale so that you accomplish your goal of buying/selling with the most amount of money left in your pocket possible. Compound interest then takes care of the rest.
Let’s look at an example. Let’s say I’m helping a 30 year old couple buy their first home. The home is priced for $600,000, has been on the market for a while, and has terrible listing photos. To the wrong agent, it looks like a dud, and they won’t even bother recommending it to their clients. To the right agent, it looks like potential.
We go take a look and we like it. The right agent enters into negotiations with the listing agent. We understand from the listing agent that the sellers really just need to sell ASAP. What’s important to them is a large deposit and a quick closing. The right agent knows we can deliver that without paying a dime more for the property.
So after some more negotiations, we get an offer accepted for $575,000. The wrong agent would probably have gotten suckered in to their client’s paying $595,000 and they’ll think they got a deal.
Just how much does this $20,000 cost over the 50 years the couple lives in the home? Let’s further assume that this $20,000 saved gets put into the stock market, which historically compounds at 8% annually. Using this compound interest calculator, that $20,000 has a future value of $938,000.
Keep in mind, you used the right buyer's agent FOR FREE.
Now, you may not be a 30 year old couple. You may not put the money saved into an investment vehicle such as the stock market. The example is extreme, but hopefully it gets the point across.
Every dollar kept in your pocket as a buyer matters. Every dollar your listing agent gets for you in a transaction matters.
The right agent understands this, and the wrong agent doesn’t care. The right agent therefore can save you and make you thousands, if not millions of dollars, while the wrong agent will do precisely the opposite.
Your gains compound just as your losses do. Don’t let the wrong agent drag down you and your family’s financial future!
Disclaimer: I am not a financial advisor, nor an accountant, lawyer, or any other professional besides being a licensed real estate agent. Consultant your financial advisor/wealth manager for all financial and investment advice.
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