Assessing the Real Risk of Risk

Purchasing a home can be very stressful.  Whether it is your first home purchase, or your tenth, you still might have reservations that lead to “analysis paralysis”, where you can’t make a decision.   

A friend of mine went through this just 24 hours before closing on her first home.  She called me and walked me through some of her concerns, which included:

  • An overzealous HOA board. 
  • The unknown state of the real estate market. 
  • Some unapproved improvements to the interior of the home. 

She was very concerned about these potential issues, and about to walk away from the deal. 

So I walked her through a “Plan B” process, where we assumed the (unlikely) worst case scenario and then determined what she would do if any of those were to become reality. 

I like to use a “Plan B” process whenever I’m have concerns about making a major decision.  It allows me to assess the real risk of any given situation much easier, by looking at the solution you’d create in the event of a negative event.  

Here’s a hypothetical example of how it works: 

Concern 1: “I’m concerned that the HOA board could be overzealous, and make my living situation there untenable.” 

Worst Case Scenario:  A contentious relationship with the HOA board. 

Worst Case Solution(s):  Proactively befriend the board members, opening a dialogue.  Then run for a seat on the HOA board.  If that doesn’t work, hire an attorney to aggressively defend your rights. 

Concern 2: “I’m planning on using the profit from this home to fund some future obligations in 5-10 years.  What happens if the market shifts downwards?”.

Worst Case Scenario:  The local real estate market drops 20%. 

Worst Case Solution:  My friend is buying the property at a 20% discount to current market rates.  This allows her to better weather a downturn.  She could also alternatively rent the property (at a profit, based upon her calculations) until the real estate market recovers.  Or delay her plans and continue to live in the home. 

Concern 3: “The home has some unapproved interior alterations, such as an interior closet.  What happens if I’m forced to remove these alterations?”

Worst Case Scenario: The cost to remove these would be $1,500. 

Worst Case Solution:  Pay the $1,500. 

By looking at the (realistic) worst case scenario, you’re able to understand the real risk of any given situation – and then proactively come up with solutions to those risks.  When you buy a home for $100,000, your realistic risk isn’t $100,000.   It’s either :

  • the mortgage cost for 10 years, because the typical real estate market cycle lasts roughly 10 years, and you just need to cover the mortgage for that period of time until you can sell the property.    OR
  • the amount of equity you could lose in a market downturn if you’re forced to sell at the bottom.   I like to estimate a 20% dip, but you can choose the number that you feel most comfortable with. 

Using a “Plan B” process can not only make it easier for you to make difficult decisions, but it also has the added benefit of training your brain to think about positive outcomes versus negative possibilities.  

Try it sometime and let me know how it works for you.