Budgets, Buckets, and Home Equity According to Thaler

Welp, I’ve officially gone down the rabbit hole that is behavioural economics. Because I’m consumed by this ‘How do people money?’ question.

How do people feel about, think about, and spend their money?

I’m reading Thaler’s Misbehaving thanks to some great Twitter recommendations and I just got through section two on Mental Accounting, which was all kinds of up my street. Acquisition versus transaction utility, sunk costs and payment depreciation… you know, the good stuff.

But oddly enough it was a paragraph on home equity in Chapter 8: Buckets and Budgets that’s stuck with me the most.

He talks about how home equity lines of credit came to be a thing (that’s HELOC for short) and how they completely changed the way Americans do money.

(Yes, I’m fully aware this is old news to most people but you have to remember that I’m a snowflake millennial who’s just coming around to the idea that a) the world existed before 1990 and b) said world might be worth learning about.)

So here’s the deal on HELOCs in the US according to Thaler…

– Until the 1980s home equity was sacred. Like your retirement accounts. You didn’t touch those buckets. That was money for future you, not present day you.

– This meant that in the early 80s people over 60 had very little mortgage debt. Paying off your mortgage—as quick as possible—was what you did.

– Then came Regan. Good ol’ Ronald and his tax reforms. Before 1986 all interest paid (on auto loans, credit cards, etc.) was tax deductible. After 1986 only mortgage interest was tax deductible.

– Hmmm. So now that mortgage interest was the only kind of interest that’s deductible, there was an economic incentive for banks to create something that lets you borrow money in a tax-deductible way. Because people love a deduction, right? Enter the HELOC.

– Want a new car? Finance it using a HELOC, not an auto loan, because you’ll get the deduction. Have credit card debt? Take equity out of your house to pay it off. And so on…

– On top of this interest rates kept getting lower and mortgage brokers became a thing, which encouraged more and more people to refinance.

What did all of this do?

“The change eroded the social norm that home equity was sacrosanct.” 

Home equity was no longer the ‘safe’ mental account it once was. It was no longer a bucket for future you, like your retirement accounts, that you didn’t touch. It was for spending and spending today.

“During the housing boom in the early 2000s, homeowners spent the gain they had accrued on paper in home equity as readily as they would a lottery windfall.”

And then he says this...

“The fall in stock prices did not impact spending as much as the fall in home prices.”

Since people still had retirement accounts as this bucket you didn’t touch, stocks taking a dip in your 401(k) didn’t change how much you were going to spend on furniture that year. Your 401(k) was still mentally filled under ‘money for future you’.

But your home? That was now a bucket of money for present you. And when people could no longer take money out of their homes to finance new cars because house values had fallen so much and/or they were underwater on their mortgage, well, you know what happened. Things went downhill fast.

Enter the 2008 financial crisis.

Here’s what’s so interesting about this to me…

How do we go from, “Here’s a sacred thing we don’t touch” to, “Burn it to the ground.” 

How do these shifts happen?

What’s going on with culture, with education, with how ideas spread… What’s all the stuff circling around a change in behaviour that facilitates it? What’s the narrative around it?

The marketing bit. Because marketing isn’t just advertising, it’s the story we tell others and ourselves.

How did we change the story?

That’s what’s super interesting. That’s what we’ve got to dig into. When we look back and when we look around at what’s happening today…

What’s the story being sold to us and what’s the story we’re selling to ourselves?

Because if there’s one thing we can count on in this world, it’s that history repeats itself.


Oh look, a house. Because home equity. Points for originality, yes? Taken near Yarmouth, Nova Scotia. 

P.S. Read this NY Times article from 2008 on bank advertising leading up to the crash. Ya. History definitely repeats itself.

About the author

Kate Smalley

Kate is a marketer, maker, and freelancer living in Toronto. She works with small businesses to help them narrow in on their purpose, share their ideas, and tell their story.

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3 Comments

  • And it’s way worse in Canada:

    25 percent of consumers pay only the interest or make the minimum payment on their HELOC.

    Most consumers do not repay their HELOC in full until they sell their home.

    The number of households that have a HELOC and a mortgage secured against their home has increased by nearly 40 percent since 2011.

    http://www.newswire.ca/news-releases/fcac-report-home-equity-lines-of-credit-may-put-consumers-at-risk-627023801.html

    And what’s not captured in the stats are the amount of HELOCs taken out to re-invest in more real estate (whether through dodgy MICs and syndicated mortgages or as “gifts” to kids to prod them into throwing it all into this blast furnace of a market).

    Anyway, the mindset is fascinating. Part of it I think (esp. the more recent hockey-stick) is the belief that real estate always goes up at high rates, so you can spend it now and come out find when you sell your house later. But also just the language: 20 years ago, who spoke about “home equity?” The focus was on the mortgage and having a house to live in.

    • “Blast furnace of a market”

      LOL. But also, not funny at all… Sigh.

      I’m seeing that with some friends, their parents are using a HELOC to make a downpayment on a house for them. There definitely seems to be this blind faith of, “it’ll work out in the end.” This has come up in group chats and someone will ask how that works (so do you own the place or your parents? whose name is in it? Is in an investment property etc?) and they don’t know. They don’t actually understand what’s going on. They haven’t asked their parents questions about it because they don’t know what questions to ask.
      Which has me thinking… OK are you now your parents retirement plan? Like if the market flops, it’s not just about how this affects your finances and your ability to pay the mortgage… but what about your parents? Can they still support themselves and their retirement or is that on you now? Do you both sink?

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