The Frontal Cortex

Buying the Wrong House

One way to understand the collapse of the real estate bubble (and our current financial mess) is as a massive case of bad decision-making. The mistakes, of course, were made by many different people and organizations: the investment banks who bought subprime debt, the credit rating agencies who gave that debt high ratings, the mortgage brokers who gave out shady loans to people with bad credit, etc. But, in the end, the bubble really began when lots of people chose to buy the wrong home. They bought homes that were too big and too expensive, fueling an unsustainable boom in new home construction. They took our mortgages they couldn’t afford.

Ap Dijksterhuis, a psychologist at Radboud University in the Netherlands (and expert on unconscious thought), has done some cool studies that look at how people shop for “complex products,” like cars, apartments, homes, etc. and how they often fall victim to what he calls a “weighting mistake”. Consider two housing options: a three bedroom apartment that is located in the middle of a city, with a ten minute commute time, or a five bedroom McMansion in the suburbs, with a forty-five minute commute. “People will think about this trade-off for a long time,” Dijksterhuis writes. “And most them will eventually choose the large house. After all, a third bathroom or extra bedroom is very important for when grandma and grandpa come over for Christmas, whereas driving two hours each day is really not that bad.” What’s interesting is that the more time people spend deliberating, the more important that extra space becomes. They’ll imagine all sorts of scenarios (a big birthday party, Thanksgiving dinner, another child) that will turn the suburban house into an absolute necessity. The lengthy commute, meanwhile, will seem less and less significant, at least when compared to the allure of an extra bathroom. But, as Dijksterhuis points out, that reasoning process is exactly backwards: “The additional bathroom is a completely superfluous asset for at least 362 or 363 days each year, whereas a long commute does become a burden after a while.” For instance, a recent study found that, when a person travels more than one hour in each direction, they have to make forty per cent more money in order to be as “satisfied with life” as someone with a short commute. Another study, led by Daniel Kahneman and the economist Alan Krueger, surveyed nine hundred working women in Texas and found that commuting was, by far, the least pleasurable part of their day. And yet, despite these gloomy statistics, nearly 20 percent of American workers commute more than forty-five minutes each way. (More than 3.5 million Americans spend more than three hours each day traveling to and from work: they’re currently the fastest growing category of commuter. For more on commuter culture, check out this awesome New Yorker article.) According to Dijksterhuis, these people are making themselves miserable because they failed to properly “weigh” the relevant variables when they were choosing where to live. Because these deliberative homeowners tended to fixate on details like square footage or the number of bathrooms, they assumed that a bigger house in the suburbs would make them happy, even if it meant spending an extra hour in the car everyday. But they were wrong.

Obviously, this don’t address the mortgage issue, or why people took out so many subprime loans. (I blogged about that several months ago.) But I think they do demonstrate how people often make bad decisions when making important decisions, precisely because they assume that thinking more is always better. Conscious thought, however, comes with its own biases and frames and, when we’re buying a home, those biases can lead to some big mistakes.

For more on the dangers of thinking too much, check out a few of Timothy Wilson’s papers, especially this one.

Comments

  1. #1 Steve Laniel
    July 17, 2008

    Behavioral economics of this sort only seems interesting when it offers productive tips to rectify the mistake. So how do you get people to weight the commute time appropriately?

    I don’t think you’ve convincingly argued here, however, that the weighting is actually inappropriate. The people who wrote “Nudge,” for instance, determine that people have made a mistake when they behave as though they’ve made a mistake — e.g., they do something to correct it. Or, on the other side, they’ve made the right decision when they do nothing to reverse it.

    That said, of course there will be reasons why people won’t correct even obvious mistakes. You invest a large sum of money in a suburban house, and it becomes very hard to sell that house and move back into the city: your kids are now in school in the suburbs and have made friends, you now own an SUV that you can’t park in the city, etc., etc.

    But still: you need to convince me that *by their own lights*, these people have made a mistake in buying those houses.

  2. #2 G. Williams
    July 17, 2008

    This reminds me a bit of Dan Ariely’s talk at the American Library Association conference recently. (Ariely is the author of Predictably Irrational.)

    When it comes to house buying, I wonder how much of this is what we’ve been taught to value in a home. There are times when I’d prefer an apartment–and I’ve noticed that stuff tends to expand to fill the space available, regardless of how much square footage you actually have.

  3. #3 Dunc
    July 17, 2008

    Hmmm… No mention of the original bad decision – i.e. the decision to de-regulate mortgage lending, which enabled the whole shenanigans to start with?

    Me, I live in a tiny apartment – but it’s only a 15 minute bus ride from work. That was probably my top priority after affordability.

  4. #4 yoshi
    July 17, 2008

    Consider two housing options: a three bedroom apartment that is located in the middle of a city, with a ten minute commute time, or a five bedroom McMansion in the suburbs, with a forty-five minute commute.

    Steve alluded to this. Buying and selling a house is a royal pain. How much does that pain factor weigh into the decision process?

    (I bought a two bedroom house in the middle of the city with a low commute factor instead of the five bedroom mcmansion in the suburbs – it was a no brainer – grandma and grandpa have to stay in a hotel and we’re happier people because of that)

  5. #5 Paul
    July 17, 2008

    This is nonsense. Let’s assume you’re right about people’s eyes being too big for their economic stomachs. For good measure, we can toss in your claim that they’re really making themselves miserable with those commutes. Fine. But people have been wishing like this for time immemorial. That is not what changed. What changed was on the supply side. Brokers with concience or incentive to be prudent originated loans, and Wall St. bought them up eagerly. In the past, those whose eyes were too big for their stomachs got denied at the bank, because the bank was on the hook if things went bad. Banks became minor players and unregulated brokerages ran the show. This is why there was as bubble, and the bubble is why the bubble burst (becuase that’s what bubbles do). Yes, people wanting more house was a necessary condition. But so is oxygen for fire. And it would be foolishness to point to the presence of oxygen as the bloggably central cause of an arson’s act.

    And you are wrong in your linked-to post about subprime loans that “By most measures, sub-prime loans are a bad idea.” Sub-prime loans make sense where they make sense and are sustainable. The mortgage firm Self-Help, begun by the people who started and run the Center for Responsible Lending, has been making sustainable subprime loans at low default rates for years. They do it because it responsibly provides homeownership to those who wouldn’t otherwise have it, and because it is possible if underwritten correctly. But, again, your larger point in that post is flawed, as its premise is that it’s the psychology of the glutenous buyer that’s central to the story. Again, that’s just not true. And the reason that it is false is the same reason why your focus on 2/28s are mistaken. The major problem, both in the subprime meltdown and in the current rise in prime defaults, is, again, the bubble and the irresponsible supply-side underwriting that made it happen. Dean Baker has demonstrated this countless times. Rate jumps after the teaser period were a problem. But 2/28s were originated on the premise that housing prices would continue to climb and that refinancing or selling for a profit would be easy as pie.

  6. #6 Texas Reader
    July 17, 2008

    yoshi – i did the same thing. i was motivated by the desire for a short commute time ten years ago (as opposed to gasoline costs) AND the fact that in the suburbs i’d be the odd single person, with no kids.

    the decision today is even better given gas prices. a lot of analysts are predicting serious declines in suburban home prices as people move to the cities to reduce their gasoline expenditures. my home value has not suffered one bit as i’m “in town” and near major thoroughfares to reach suburban employment centers, as well as near downtown.

  7. #7 Donna B.
    July 17, 2008

    I blame HGTV.

  8. #8 Julie Stahlhut
    July 17, 2008

    I can’t stand big houses. Or, more accurately: I don’t give a flying leap one way or the other if someone else has a big house. Just as long as I don’t have to live in one. (I feel the same way about big cars.) Right now, since we’re between long-term situations, we’ve been renting for over three years. We’d like another house eventually, but we’re not going to rush into it.

    Given that I dislike housework and yardwork, hate being in debt, would rather spend disposable income on restaurants and travel (which are a lot cheaper than owning a too-big house, when you think about it,) and am married to a person with the same opinions, I’m not likely to get into the aforementioned bad situation on purpose. The only thing I worry about is if we get pressured to move to an expensive city for job-related reasons. We both also hate long commutes, so we’re going to have to dance around some interesting edges if our best long-term job prospects land us somewhere snooty and overpriced. Ugh.

  9. #9 Leni
    July 17, 2008

    I know it’s kind of mean, but I find myself secretly snickering when I hear the suburbanites at work complaining about gas prices. I know it’s not nice, but what else did they think was going to happen? That gas prices were going to go down? That they would “need” an SUV to haul around one kid and a diaper bag? Or worse yet, they decide to have 3 or 4 kids and then have the gall to complain about what a hardship it is to haul them around in said SUV from the burbs?

    I guess I just have very little sympathy for them. Especially considering what a blight the McMansion-hoods are on the countryside and how rapid natural habitat is dwindling for so many animals. There should be unpleasant consequences to that, shouldn’t there?

  10. #10 Anna K.
    July 18, 2008

    The study does sound neat . . . though I think one of the issues that American home buyers face that home buyers in the Netherlands may not, is that American public schools are locally controlled. We bought our house in what’s considered a ‘good’ school district. Just generally speaking, apartments in urban areas are in relatively unsafe or inadequate school districts; the suburbs tend to have better and safer public schools. So the choice isn’t always about an extra bedroom, but whether your kids have to deal with gang violence and not enough textbooks at school; or not.

    If you don’t have to take the quality of the public schools into account, then your housing options open up.

  11. #11 wenchacha
    July 18, 2008

    When we first bought a house 25 years ago, the Realtor recommended buying “as much house as you can,” for the money. We qualified for a far greater mortgage than we were comfortable taking on. This happened again when we “moved up” to the suburbs.

    How are buyers, who buy maybe two or three houses in a lifetime, supposed to interpret bank approvals for loans that will push them to the limits of their budget? The bank does this millions of times a year: they must know something we don’t know! There is definitely some assumption that the home buyer will earn an increasing amount of income as the years go by. It’s a major flaw in the process.

    Hey, we were raised to be frugal, so pat us on the back. I think lots of people were led like little lambs into signing on for more than they could afford, with promises of increased home equity in just a few years. Sort of like, “you’ll be losing money if you don’t buy this house.”

    I also agree with Anna K. on the school issue. In our city, taxes also increase the cost of city housing. When business leaves the city limits, it falls to the homeowners to pony up for the services a city provides. If the property taxes for a $100K home in the city limits are the same as for a $150K home in suburbia, a home buyer is going to weigh that along with number of bathrooms.

    Don’t forget the long-commute dilemma: in some parts of the country, working people can’t afford a home close to their city job. That puts them further away from work than is practical, but allows them to purchase a home.

  12. #12 E Miller
    July 18, 2008

    I would love to buy a home close to my husband’s office! The problem is we can’t afford to. If we want to get a school district that is worth anything we would be able to buy a 2 bed 1 bath house for $499,900. That is the cheapest house on the market right now in that area. We are not willing to pay that much for such a small house. I don’t want my son and daughter to have to share a room. To get into a 3 bed 1 bath we could move to $675,900. Sure the bank will approve us for that ammount, but we know better. We will soon be purchasing a house in the suburbs that is a 4 bed 2 bath in the 300K range. That leaves room for the gas issue in our budget. There is a reason so many people with familys commute.

  13. #13 dBH
    July 18, 2008

    Actually is fascinating, but misses the ‘luxury’ factor, the sense I have is that people will go to great lengths to justify to themselves up-buying, even with negative consequences, in order to feel more prosperous. I think the end of cheap gas may have a moderating effect too. Lastly, I’ve seen urban planning studies that talk about the suburban culture in the US being unique and a consequence in part of zoning laws. Big malls near freeways in transit to/from suburbs that have little commercial infrastructure compared to Europe having series of small townlets with centers that provide individual stores and restaurants as well as some living. Big cities with all commercial buildings vs. Europe where buildings are often commercial on first floor and residential above that. Etc. Cheap gas and cheap highways (no tolls) enabled that, but many are reconsidering the wisdom, and lack of community that results.

  14. #14 xmilestegx
    July 18, 2008

    Commute was a factor for me, but I work in the suburbs and live in the city. I would say my 45 minute, traffic free, drive is much more pleasurable than the more likely 45 minute, traffic intense, drive. I also find driving to be relaxing when not stuck in traffic. It allows me to be alone wiht my thoughts and prepare for my day or evening.

    I agree with those the moved into the city and minimize space as well. I have minimized my posessions as much as possible, part consciously and part due to lack of storage. a big house just means you have to own a bunch of useless stuff you’ll never use except to pack when moving.

  15. #15 Dan
    July 18, 2008

    The calculations get really interesting when you consider that time equals money. If you figure out how much money you make in an hour then work out how many hours a year you spend commuting you realize how costly it is to have a long commute. Suddenly renting out the roller skate rink for the kids birthday party and the occasional hotel room for grandpa and grandma looks like a bargain.

    The financial picture gets even better if you can ride your bike to work. I am single and live int town and bike commute. I have a car that I only drive for the occasional trip. If I were married I would sell my car in a heart beat. That would mean a whole lot of money not spent on a car, insurance, gas, and maintenance.

  16. #16 randy
    July 18, 2008

    People who buy in the far flung suburbs get what they deserve — falling home prices and high gas prices.

    When they bought the house, they knew that the commute would be bad, so they figured that if the commute would be horrendous, life should somehow compensate. So they have a luxury car to feel good on the road, and the huge mega-mansion so that when they arrive at home, they have a big flat screen tv, a kitchen the size of a banquet room, a yard for pro football, and so on. This way, once home, they never have to leave home again. (Except, of course, for the long rides to the grocery store.) It’s an example of cocooning.

    Then more people move out to their special little place, and they have to nerve to complain about how traffic is getting worse, and the commute longer. What did they expect? No more cars or houses once they moved in? They jump for joy when the upscale retail markets move in close to home, not realizing that that encourages more mega-mansions, more traffic, and longer commutes in the end. Then they want more roads built (at everyone else’s expense, of course) to make their commute easier.

    Gramm was right. We are a nation of whiners.

  17. #17 Rachael
    July 18, 2008

    Your argument implies something that any republican would balk at: sometimes the purpose of government is to place constraints on the ability of people to make free financial choices.

    Why would we regulate our own ability to make free choices? Well, clearly, the poor choices of some (and by that, I mean the choice of people to own homes they can’t afford, as well as the choice of the company to enable it) are severely impacting the economic welfare of all. Whether you’re a democrat and concerned about helping the whole through the individual or a republican and concerned about helping yourself, the conclusion should be pretty obvious. Deregulation = bad for everybody.

    (And as for the argument that the market would come to equilibrium if left to itself, I think history shows us this is not the case. People always have and always will want “more”, and they will harm their own economic futures by acting on that motivation).

    My husband and I each work less than a mile where we live, and we can afford a convenient house like this because it is none of the following: flashy, big, or new. Problem Solved. We deal with some peeling wallpaper, and in turn we don’t ever drive our cars (or pay for gas) and we have an extra 2 hours in our day to enjoy life.

    Part of a solution for many of our social woes would be to have builders build more responsibly – smaller footprint homes can be cheaper, better for the environment, and easier to maintain.

  18. #18 Karel Holloway
    July 18, 2008

    Some folks buy out of town not for a McMansion but some other really, really pleasant amenities.
    Blue herons in my neighbors stock pond. Actually seeing stars. Realizing that the moon has phases. A chance to walk the dog in the woods — every day without driving to a park.
    No nieghbors fueding in the apartment overhead. No nieghbors headlights shining in the bedroom window at 2 in the morning. Or, for those in houses, windows that don’t look into neighbors windows. And let’s don’t forget the homeowners associations that tell you where you can park a car, what flowers to grow and what color your roof is supposed to be.
    Perhaps this is mean and selfish — I’m using the earth’s resources for my own happiness. But on this I’ll be selfish. I’ll drive a smaller car, make fewer trips into town, plant trees (and a big garden so my nieghbors can have fresh squash too), avoid overwatering the lawn.
    May not be the most rational cost-effective choice, but it is the happiest choice.

  19. #19 Richard Rush
    July 18, 2008

    The purchase decision for a house is, to a considerable extent, not really about the house, but rather is about being well regarded by friends or peer group. It’s the old “keeping up with the Jones” syndrome. In that context the long commute time is just part of the cost of doing that.

    It is extremely difficult for most people to make decisions without giving enormous weight to what other people will think.

  20. #20 Robert Thille
    July 18, 2008

    Part of the problem with buying the ‘right’ house is the tax situation. My wife and I moved from Santa Barbara, CA, from a 1500 sqft house to Sebastopol, CA. In order to take advantage of the tax laws and not pay capital gains on the appreciation of our Santa Barbara House, we had to buy a 2800 sqft house. Now granted, it’s not the wrong house from the mortgage point of view (our equity/loan stayed right about the same), but our expenses and property taxes went up. If the taxes were calculated on the owners equity, rather than the value of the house, we could have moved to a more ‘right sized’ (smaller) house, and probably owned it outright. But with taxes on the capital gains, that didn’t make sense.

  21. #21 gaston monescu
    July 18, 2008

    great link to the new yorker article…
    p.s. its surprising how many choices people make which reduce the ‘quality’ of their life in exchange for some physical object like a bigger house or nicer car. i word it this way to highlight how not-out-of-the-ordinary it sounds. its the(and i cay this with no sarcasm) american way. what do people really want/do we REALLY know what we want? most people would say yes, but there are a number of questions one could pose which are difficult to answer…

  22. #22 Jeff
    July 18, 2008

    We might also be at the end of a game of musical chairs and now people are stuck in the house they are in.

    Coventional wisdom 2 years ago would have been “I get in trouble making the payments when my A.R.M. goes up, I can always sell it and make a quick $50K.

  23. #23 AnnR
    July 18, 2008

    I would be interested to know how old many of these McMansion buyers are.
    We got caught in a down real estate market in 1982. It was a number of years before our home appreciated. When we bought again in 1995 the market was OK but rates were rising.

    We had no expectation that the house we purchased in 1995 would be a cash register, it was a place to live.

    I agree that people dream on about things that are very small factors (the once a year holiday), but I think some of these purchasers were buyers who had not lived through a down market before and didn’t have realistic expectations about how stuck they were going to be.

  24. #24 Babalouis
    July 18, 2008

    Interesting but flawed thinking. The commute may have more to do with job changes. It may not be possible to live safely in the inner city. There are about 25 more variables that come to bear on the decision than you are mentioning. This article is just a lot of bad simplification.

  25. #25 Mark Lees
    July 20, 2008

    This made me think of two things:

    1. A good friend of mine recently (a little over a year ago) sold histhree bedroom detached house and bought a three story, six bedroomed house with five bathrooms/toilets – FIVE! Is just the two of them, they have no kids and aren’t going to have any – Ias ked him if he had become incontinent needing five toilets for just two of them.

    2. About 15 years ago a woman my mother knows decided to sell her house in London and move to live near a relative about four hours drive away. She contacted the estate agents, got a list of properties she was interested in, and spent a couple of days visiting all the houses.When she returned to London she put in an offer, which was accepted, for the house she was interested in. A few months go bye during which the legal busienss is completed and the house, which she had not visited in the meantime, is purchased. She organises the move – and turns up with removal van at the house she has purchased to find that she has literally bought the wrong house. I know it is hard to believe but she confused the two properties, put the offer in for the wrong one and because of the distance had not visited during the intervening period.

    As for commuting – I decided quite some time ago I work where I live, and 20-30 minutes is the most I’d be prepared to travel. I have had offers of substantially more money, but however much they pay me I can’t buy back the time spent travelling.

  26. #26 Melissa
    July 20, 2008

    There was a comment about choosing a “good” district in a response to this article. It is important to note that today’s New York Times talked about the “reverse” white flight back into the cities. It is a privilege to be able to make the “choice” of suburb versus city that for the last 50 years, only a small subset of the population was able to make. At this point, those who have the financial resources to “choose” the city apartment need to put the resources that we have into the communities where we choose to live. That means sending your children to the city school district, getting involved in local politics, etc. Let’s not let the wealthy “take back” the city without exercising civic responsibility.

  27. #27 Larry Angell
    August 4, 2008

    Excellent article on the flaws of human nature. If the home is more than you can afford and too distant to be affordable, don’t buy it. Don’t even build it yourself.

    I counsel people all the time to live within their means, but there are many who absolutely will not. Those of us who live within our means will eventually have to take care of those individuals who are incapable of making good choices.

    It’s not fair, it’s just the world we live in.

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  29. #29 okey oyna
    February 21, 2009

    Interesting but flawed thinking. The commute may have more to do with job changes. It may not be possible to live safely in the inner city. There are about 25 more variables that come to bear on the decision than you are mentioning. This article is just a lot of bad simplification.

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  34. #34 Build Your Own Home
    February 4, 2010

    I would love to buy a home close to my husband’s office! The problem is we can’t afford to. If we want to get a school district that is worth anything we would be able to buy a 2 bed 1 bath house for $499,900. That is the cheapest house on the market right now in that area. We are not willing to pay that much for such a small house. I don’t want my son and daughter to have to share a room. To get into a 3 bed 1 bath we could move to $675,900. Sure the bank will approve us for that ammount, but we know better. We will soon be purchasing a house in the suburbs that is a 4 bed 2 bath in the 300K range. That leaves room for the gas issue in our budget. There is a reason so many people with familys commute.

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  36. #36 Oto kiralama
    April 5, 2011

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    May 24, 2011

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    Given that I dislike housework and yardwork, hate being in debt, would rather spend disposable income on restaurants and travel (which are a lot cheaper than owning a too-big house, when you think about it,) and am married to a person with the same opinions, I’m not likely to get into the aforementioned bad situation on purpose. The only thing I worry about is if we get pressured to move to an expensive city for job-related reasons. We both also hate long commutes, so we’re going to have to dance around some interesting edges if our best long-term job prospects land us somewhere snooty and overpriced. Ugh.

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