The Mistakes People Make: Financial Decision Making when Buying and Owning a Home

Abstract

Financial sophistication does not uniformly impact home ownership decisions. Sophisticated households are less likely to pay too high a mortgage rate and more likely to refinance when financially advantageous to do so but more likely to over pay for a house and less likely to default when underwater. We argue purchasing a home or defaulting are emotional decisions while deciding on mortgage terms or to refinance are analytical decisions amenable to the analyses of sophisticated households. Consistent with this, households learn over time to make better mortgage rate and refinancing decisions but not better house purchase price decisions.

Keywords: Household Finance, Mortgages, Refinance, Option Value, Financial Crisis

JEL Classification: D12, D14, G11, G2