How Is Your Mental Accounting?

The foreclosure situation of the past few years has some people taking inventory of how they're handling their finances like never before.  Have you thought about how you spend your money?  Have you thought about how you spend some money as opposed to how you spend othermoney?

I saw a great article by Tara-Nicholle Nelson that makes some great points about how we spend our money and how that has contributed greatly to today's economy.  A mindset was created where people thought they had money when they didn't...and borrowed against it.

It's what Nelson calls "mental accounting," which is how we each intuitively look at money from different resources in different ways.  As an example, she points out that most of us spend windfalls, lottery winnings and even earnings on investments more freely than money we work for.

She explains, "I believe that this mental strategy, which seems sensible in many cases, times millions of homeowners who practiced it during an era of rapidly inflating home values, contributed in no small part to the foreclosure crisis we're still reeling from at this very moment."

In short, the equity built up so quickly during the boom of the early 2000's seemed endless and many people treated it like a windfall when it really wasn't.  Once values plummeted, that equity was gone in the blink of an eye and those people were still left with the debt incurred based on that equity.  Nelson refers to it as "easy value."

"That seemingly endless, sourceless home equity which was accruing in homeowners' accounts - mental and otherwise - seemed like a windfall; fast, easy money that could be spent without compunction," according to Nelson.

If the foreclosure crisis directly affected you or just has you thinking in "what if's," take time to assess your mental accounting and how you handle windfalls and "unearned" money.   These decisions can have a profound impact on your financial state and your ability to get loan approval in the future:)