As a homebuyer, it can be difficult to know when you are at risk of overpaying for a home or when to walk away. And it is especially difficult right now when home price growth is at a record high of 17%, nearly two-thirds of offers face bidding wars, and 42% of homes sell above list price. Here are some tips to reduce the risk that you make a decision you end up regretting.
Before you even start going on home tours, figure out what your budget is. How much money do you have saved and how much of your savings are you willing to tap for your down payment? How much can you afford to pay for your monthly housing costs including your mortgage, home insurance, and property taxes? Figure out how much you would like to spend and what your absolute limit is.
Next, start browsing homes on Redfin.com to determine what kinds of homes fall within your budget. You’ll likely find homes you like that are within your budget but not in your preferred location, or vice versa; figure out which is more important to you. Your real estate agent can help you understand how much different types of homes typically sell for and how that is changing in real time. Additionally, Redfin.com has information about the level of competition in different neighborhoods, which can tell you how much homes sell for compared to their listed price. Adjust your expectations about home prices according to that information.
If the homes you want are above your budget, you have a couple of options. You can choose to rent instead and work on saving more money for your dream home. Or you can compromise: Buy a condo instead of a single-family home, or buy in a more affordable neighborhood. Even if you buy a home that is less than ideal, you can work on saving money to move up to your dream home in the future. And when you do move up, you should have some home equity you can cash in on to buy your next home.
“The only reason for urgency is that prices are increasing every month,” said Boise Redfin agent Kristin Lopez. “That means you have the opportunity to buy a smaller, starter home and build equity as prices rise. Then in a few years, you can sell and buy your ideal home.”
Once you start touring homes and making offers it is important to be self aware about how your emotions may be impacting your decision making. Here are some common mistakes buyers make:
Try not to fall in love too quickly. Once you start picturing your future in a home–imagining hosting holidays or picking out furniture–it could become more difficult for you to walk away if you get into a fierce bidding war. It’s a good idea to think about if the home will suit you into the future, but try not to get too invested in that future. People tend to value a home more if they already feel like it belongs to them. Behavioral economists call this the endowment effect.
Don’t fixate on the list price. In a highly competitive market, sellers may list their homes for much less than what buyers are willing to pay in order to induce a bidding war. If you focus too much on the original list price, you may be reluctant to make an offer high enough to win. Behavioral economists call this anchoring.
“If you have a $600,000 budget, look at $500,000 homes,” said Sacramento Redfin agent, Andrea White. “Don’t look at anything higher than that, so you can have room to offer above list price.”
Think for yourself. If everyone else is offering to waive a financing contingency, you may also be tempted to do so, even though this is more risk than the typical financed homebuyer should be willing to take on. Behavioral economists call this herding. Remember to only make offers that make sense for your own financial situation.
Take a breather if you need it. After losing out on bidding war after bidding war, you may become exhausted to the point that you just want it to be over with. This could lead you to either give up too soon, or to buy a home that you may end up regretting. Behavioral economists call this decision fatigue.
“Buyers start out excited,” said Salt Lake City Redfin agent Chad Snow. “Then once we go through what it’s going to take to win, it makes them more apprehensive. Fatigue happens around offer three or four. That’s when they ask me, ‘is this even going to be possible?’ But I have had many success stories. One of my buyers had been beat out on two different homes, but the third try was the charm. We didn’t have the highest offer price, but we beat out three other buyers thanks to some close cooperation and contact with the listing agent.”
Once you find a home you like within your budget, remember that things can go wrong after you buy. Thinking that these problems won’t end up costing you significant time and money is what behavioral economists call optimism bias. So it is important to think about the risks and whether they are worth the reward.
The most common risks are costly repairs (which a home inspector can help you identify), and the risk that you have to sell suddenly before you build up equity. If you think you might have to move in the next five years, perhaps because of a career change or due to a change in the needs of your family, it may be wise to rent instead of buy a home.
Here is an example of how a homebuyer might end up happy or regretful about their decision to buy a home:
Scenario
Jaime and Jordan have been searching for a home for months but every time they put in an offer on a home they are outbid. They just toured a home that’s listed for $400,000, which is already at the top of their budget, but it is their dream home, and they could see themselves living there for over 10 years. According to the inspection report, the plumbing is old but still functional. They submit an offer at list price, but they learn another buyer has outbid them, and is willing to escalate their offer up to $499,000. Jaime and Jordan decide to drain their emergency savings so they can offer $500,000. Will Jaime and Jordan end up regretting this decision?
Good outcome
After purchasing the home, Jaime and Jordan immediately double down on saving so they can replenish their emergency savings fund. Instead of buying a new car, they keep sharing their old car, and they forgo vacations. In just one year, they have replenished their emergency fund. They haven’t had any issues with the plumbing, but they can rest easy knowing they have enough saved to cover a major repair. Since purchasing their home, rents in their area have increased so much that their monthly mortgage payment is now less than what they would have had to pay in rent. Even though Jaime and Jordan have no plans to sell, they are happy to see that the Redfin estimate for their home is now $525,000, so they don’t believe they overpaid.
Bad outcome
Only a month after purchasing the home, a pipe bursts. Jaime and Jordan don’t have any emergency savings, so they have to use their credit card to pay $10,000 to update their plumbing. After a year, Jaime gets a job offer in a new city. It’s Jaime’s dream job, so they decide to sell their home and move. Unfortunately, their home only sells for $500,000, the same amount they paid for it. After paying 5% in real estate fees, Jaime and Jordan end up $35,000 poorer than they were before buying the home.
What would you have done?
Knowing what could go right and what could go wrong, would you have bought the home if you were in Jaime and Jordan’s shoes?
