Financial Decision Making When Buying and Owning a Home

Abstract

In this paper we investigate if financially sophisticated households, as measured by schooling and work experience, are less likely to make financial mistakes when buying and owning a home. Surprisingly, we find that financial sophistication does not have a uniform impact across households’ financial decisions. While sophisticated households are less likely to pay too high a mortgage rate and more likely to refinance when it is financially advantageous to do so, they are also more likely to over pay for a house and less likely to default when significantly underwater in their mortgages. We argue that some decisions, like purchasing a home or defaulting on a mortgage, are emotional decisions while others, like deciding on mortgage terms or when to refinance, are analytical decisions more amenable to the analyses that sophisticated households are able engage in. Consistent with this, we provide evidence that households learn over time to make better mortgage rate and refinancing decisions but not better house purchase price decisions.