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Different thinking, different outcomes; a case study! January 5, 2009

Posted by shaferfinancial in Uncategorized.
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I have been talking about how different thinking, different psychology can make a huge difference in one’s results over the last few months, when what drops in my lap is a perfect example.  In 2006, I made a series of sales calls to clients encouraging them to refinance out their excess home equity.  My reasons were simple, in Florida we are always at risk of hurricanes and it is always best to have your $$ more liquid.  Some of the people took my counsel and refinanced to 80% loan-to-value, putting the equity into EIULs, money market accounts, and paying off car loans, some didn’t.   As it turns out two families that I had called ended up in 2008 having to sell their homes because of job losses.  One family (couple A) did not re-finance keeping their 30 year fixed loan at 6.5%.  The other couple (couple B)  did re-finance up to 80%, into a interest only loan @ 6.25%,  paid off their cars and started funding an EIUL.  They both had very similar homes in very similar neighborhoods that appraised within $2,000 of each other when they originally bought in 2002.

Now, I heard from the realtor that the one couple that had chosen to not re-finance were really glad and even commented that my ideas were truly bad.  Both couples understood that home values had plummeted in the area, and wanted to exit their homes without having to write a check at closing, so they gave this realtor the same mission of not having to write a check at closing.  Now remember, 1 couple had taken out $70,000 in equity in 2006, while the other hadn’t.  The realtor priced the homes a little different because of the goal.  Couple B, with the re-finance were priced 15% above the other couple.  Well both of the houses sat on the market for several months with no action, so the realtor suggested lowering the price, which the non re-finance couple (A) accepted.  The re-finance couple stuck to their guns of not writing a check at closing, so could not go down any lower.  The first couple were able to sell their home the following month after negotiating the price down even more.  The second couple started to get some interest, but always said that they were unwilling to sell for less than what was owed.  And two months later they sold their home.  After negotiations they ended up bringing a check for $15,000 to closing, which they had put aside when they refinanced.  Bad deal you say.  Should have not refinanced you say.  Well, actually no. They sold their home for $45,000 more than couple A.  You see, the realtor told me that the people who bought their home, fell in love with it, and during negotiations were consistently told that the owners were not willing to go below their mortgage amount so it set a floor for negotiations.  Psychologically, the new buyers understood the situation and it truly affected the negotiations.  While couple A who had all that equity, were psychologically willing to lose it, in order to get out of their predicament (transferring to a different area, had car payments, etc.), and they did.  Now, although it wasn’t pleasant for couple B to bring  that $15,000 check to closing, they had use of the money for two years and had kept it liquid for emergency situations like this. They also had no car payments, and about the same mortgage payment as couple A because it was an interest only loan.

Now, some people might think that this was a function of luck.  However, I believe it was a function of planning and pyschology.  You see, couple B had lower debt service because they had paid off their cars, and more reserves because they had saved the rest of the equity while couple A were focused on getting out of the situation as fast as they could so they didn’t have to carry a mortgage and rent in another area where their new job was located.  I also suspect that they had little in the way of reserves to carry them through.  They had not planned for this situation, while couple B, had at least positioned themselves to make it through a bad situation.  Hence, the different psychology and the different outcomes!

Rene Descartes once famously opined “I think, therefore I am” starting a whole philosophical movement, which doubts what our senses/emotions tell us and trusts our reason above the senses.  Reason tells us that excess equity sitting inside a home is both dangerous and useless (see equity management), while our emotions tells us it is safe and secure sitting inside the walls of our home.  Just like our emotions tell us to sell our mutual funds/stocks because the market is down.  Both times we are much better off using our reason over our emotion!


1. Rachael - January 5, 2009

Thanks for the information…I bookmarked your site, and I appreciate your time and effort to make your blog a success!

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