A study on home wealth and overpayment found that homebuyers with equity in their previous home tended to overpay by an average of about $8,000, or 2 per cent, when purchasing a $400,000 home.
For every dollar of equity gain, the seller pays 7.9 cents more on the next home purchase, said Gregor Schubert, an economist at the Anderson School of Management at the University of California, Los Angeles, and a co-author of the study. As a result, high equity sales tend to mean a larger overpayment on a new home.
The study presents two main theories to explain this phenomenon. One, the higher the equity, the lower the financial restrictions. As a result, these buyers can consider a wider range of homes and thus may find a more suitable home and be willing to pay a higher price.
For another, equity-rich buyers can offer higher prices, and sometimes do so in order to avoid spending a lot of manpower searching for specific information about the value of a new home, or to scare off other buyers. In both cases, this can lead to bids that are higher than they actually need to be.
To reach their conclusions, the researchers looked at Zillow's data over a 25-year period from 1996 to 2021. The average household lived in the property for 6.6 years before selling and realised an average equity gain of $86,244, which equates to an overpayment of $6,899 for their next home. To determine when homebuyers overpaid for a home and by how much, the researchers analysed home price trends in the neighbourhood where the new home was located as well as any unique attributes of the home.
The researchers found that homebuyers were more likely to overpay when they had difficulty determining the price of a particular home; for example, when the home was different from other homes in the neighbourhood, or when easily observable data points such as the age of the home or the number of bedrooms defined the overall value of the home less well.
The researchers said they were able to determine that overpayments existed in such cases in part by monitoring future sales to see if the misrepresented purchase price resulted in the persistence of higher values.
Overpaying for a home can have an impact on an entire community and lead to higher housing costs across the country, Schubert said. For every dollar of equity gain a seller receives on the sale of a home, the average home price in the neighbourhood rises by 8.9 cents over the next six months, the study showed.
When more buyers with large sales gains from other markets start looking for homes in a city, that tends to accelerate home price growth in the target area, he said.
Schubert advises homebuyers who don't want to spend more money to be aware that having the money but not the patience to compare the home-buying process likely means they'll overpay for their next home.
And in popular markets where home prices are rising rapidly, buyers should consider waiting until high net worth buyers are less likely to be impatient to drive up prices.
Says Schubert: "If you want to close quickly and you've made enough money on your old home to afford it, then a higher offer might achieve that result - but at the cost of a lower likelihood of reselling your home for a hefty profit."
Homebuyers who don't need a mortgage often negotiate discounts with home sellers who want a quick and smooth transaction. One study found that all-cash deals were 11 per cent more favourable than those with a mortgage.
But Schubert and his co-authors found that all-cash homebuyers with equity are losing their edge. "They get a net discount on their cash deals, which is reduced by high equity-mortgage overpayments," he says.
