What is... | February 21, 2012

What is a broker?

For many the term broker conjures up an image of financial traders shouting instructions to buy and sell across a crowded room. In fact people buying houses, cars, insurance contracts or mortgages will often use a broker, also known as a dealer or agent.

Perhaps without realising it, many people come across brokers several times a year – with implications for how they use their time and money.
This vision of brokers shouting “buy” and “sell” is dated (particularly as large financial transactions are now usually made via specialised computer systems) but it still provides a good example of the basic work of brokers.

Stuck in the middle
When it comes to everyday purchases most people are happy to buy directly from the shopkeeper.
But for financial transactions, such as buying insurance or taking out a mortgage, people often use a third party who can connect them with a seller. This third party is a broker. Depending on circumstances, it can make sense to use brokers to sift though a large number of companies providing similar products to find the product with the best price and best characteristics for the buyer.

Time is money
ING senior economist Ian Bright blogs about comparing prices when renewing his car insurance contract – a process that took “my spare time over several days”. The story is a reminder of adding in the value your own time when buying – as in economics terms, the “opportunity cost” of comparing prices can be high. It might mean sacrificing time that could otherwise be spent doing activities that are highly valued, such as spending time with friends and family.
Using a broker might save the buyer time.
In the case of buying a property, it would be an immense task for a househunter to find which homes were on the market without using an estate agent.
Websites can help buyers access information on and compare the prices of many financial products. As a result, using a broker may seem unnecessary. However, when buying online, it is still necessary to completely understand the product purchased.

The value of knowledge
Valuable brokers will have specialised knowledge to match the buyer with the product. Going for the cheapest car, house, insurance or mortgage deal may not always be the best option – details matter.
It might be that brokers have specialised knowledge about the market, without which, the buyer is at a disadvantage. A common example is the used car market but it can apply in housing and investing as well.
An analysis on the blog RiskHeads examined five criteria for buying insurance – cost, ease, speed, peace of mind, data security – and rated a broker over buying direct.

Something for something
Brokers will charge a fee for their services, perhaps as a percentage of the transaction or as a fixed tariff. It is important that buyers and investors know how the fees are structured and how much they will be paying.
At times this can be difficult to figure out. Some brokers charge a one off fee for setting up a transaction, others by an hourly rate and others by a combination of fees, such as trail commission that can last many years. Because these fees can add up to large amounts over time, it is worth asking how the broker will be paid before agreeing to a transaction.
The way brokers are paid may affect the way they approach a deal. The book Freakonomics showed that estate agents in Chicago on average made 3% more on the sale of their own homes than on those of their clients. The reason was that when it came to their own property they were prepared to hold out for a better offer rather than secure a quick sale.

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Phil Thornton
Phil Thornton

Lead consultant at Clariti Economics