I recently read and reviewed Carl Richards’ "The Behavior Gap," which presents a series of Sharpie-on-napkin sketches and corresponding commentary intended to correct the most common behavior gaps in the realm of financial planning and investing. Richards coined the phrase "behavior gap" to refer to "situations where our behavior leads us to subpar results."
In the wake of reading Richards’ book (which, by the way, I strongly recommend if you’re at all interested in simplifying your personal financial plans while upleveling their effectiveness in helping you live the way you want to), I can’t shake the notion that there are a number of very common behavior gaps in the real estate market as well: I’m talking about ways in which our emotions and psychology and behavior causes subpar results in our dealings with our homes, primarily, not investment properties.
Here are the top three behavior gaps that I’ve noticed consistently foul up the life and financial results of real estate consumers:
1. Walking away when you can afford to stay put, because of "the market." I recently got a question from a reader who apologized at the outset for asking a question that might seem obvious or stupid, but wondered if I could explain why someone who had lost value on their home but had planned to be in the home for 20 or 30 more years would short-sell it or walk away from it.
The reader simply didn’t understand why someone would do that (someone meaning the people she was reading about online and hearing about in the news).
Her question was of the sort that is so obvious that many people completely miss it. The fact is, the reason people sell or walk away at the bottom of the market is panic. Fear. Plain and simple.
Now, of course, I’m excluding those who lost their jobs or otherwise cannot afford their home loans, or who own(ed) homes that are no longer functional for their families (like the guy I know who bought a loft in ’06, planning to sell when he started a family, and now has a wife and son that simply don’t function well in the wide-open industrial space of his home).
Actually, I’m particularly talking about people who have home loans they can well afford and who, at the time of the market crash, had planned to be in their homes for many, many years more. When these people note their negative equity and walk away from their home strictly for that reason, not only do they incur harsh and unnecessary housing, lifestyle, credit and (in some cases) tax and legal consequences, they also lock in losses they might not have incurred if they simply stayed put in the home, as they’d originally planned.
2. Selling at the bottom of the market and/or buying at the top, because of how home values have moved. Richards actually mentions this one outright, wherein people see how much money their homes have lost, lose faith in real estate and sell at the bottom of the market; or conversely, see how rapidly homes are gaining value and decide they must get a piece of that appreciation by getting into the market.
I’d actually expand this even further to include people who heavily borrow and spend profligately against their homes because the value is so high, which creates a home that is in deep negative equity should the market decline even a smidgen.
For your personal residence (versus an investment or retirement property), the smart approach is to virtually ignore the market when you’re making a decision about when it makes sense to buy or sell. Rather, take into account circumstances such as your life, your job and income, your personal finances and credit, your vision and plan for your future, your family’s space and location needs, and such.
Then, factor in market dynamics only after you’re done building out your life and your homebuying or selling plan, as when you’re putting the specifics for executing your plan in place, like how much to offer, or which lender to go with.
3. Buying a home prematurely. This means buying a home before you’ve:
- been on the job long enough for it to be stable and/or for you to know you like it;
- saved enough cash for a meaty down payment, and your wants and needs, and cash to cushion against unexpected (but somewhat predictable) crises;
- created sound financial habits, including life and disability insurance; or
- built up a strong credit history.
Premature buyers are the ones who tend to panic the most during transactions, often because they’re constantly trying to find a workaround to a lender requirement they don’t meet or trying to scrape up a few extra thousand dollars at the last minute because they just didn’t have much, if any, cushion saved at all.
These are the buyers who can’t really afford the sort of home they need to meet their families’ needs, so they can waste a stress-filled few months or years of their own lives house hunting in a desperate effort to luck into a market-beating deal, rather than taking those years to focus on their careers, increasing their income and saving up more money for their down payment.
A few years back, they were the buyers who took unsustainable home loans in an effort to break into the bubbly market before they were priced out.
Even today, after closing, they become the homeowners who are forced to rely on credit cards or fall irretrievably behind on their mortgage payments when they have an unexpected job loss or injury that even briefly interrupts their income.