How Does a Market Crash Affect Homeowners?
If home values fall quickly, purchasers may find themselves with underwater mortgages, which means they must either stay in the house until the market recovers or sell and lose money. Homeowners owe more on their mortgages than their homes were worth and can no longer just flip their way out of their homes if they cannot make the new, higher payments. Instead, they will lose their homes to foreclosure and often file for bankruptcy in the process. The housing crash begins to take its toll on homeowners and the real estate market.
The housing market has encountered significant obstacles over the previous century, but none, with the exception of the Great Depression of 1929, contributed to the decline in home prices that occurred during the Great Recession of 2007. Neither the 20 percent interest rates of the early 1980s nor the devastation of the savings and loan sector in the early 1990s led to a similar drop in property values.
<<<Also Read: Will the Housing Market Crash in 2024? >>>
It is also worth remembering that not all economic downturns chill the property market. In reality, throughout the 2001 recession, the housing market and house demand remained strong despite the economic slump. Throughout the course of the last century, the housing market has been subjected to a number of significant obstacles; but, with the exception of 1929’s Great Depression, none of these problems have resulted in a decline in home values on par with that of 2007’s Great Recession.
The interest rates of 20 percent in the early 1980s and the devastation of the savings and loan business in the early 1990s did not lead to a similar drop in the value of homes. It is also important to note that the housing market is not always affected negatively by recessions. Despite the fact that the economy was in a slump during the recession that began in 2001, the housing market and demand for homes continued to be healthy.
The previous housing bubble in the United States in the mid-2000s was caused in part by another bubble, this time in the technology industry. It was intimately tied to, and some believe was the cause of, the 2007-2008 financial crisis. During the late 1990s dot-com bubble, many new technology companies’ stock was purchased quickly. Speculators bought up the market capitalizations of even firms that had yet to create earnings. By 2000, the Nasdaq peaked, and when the tech bubble burst, many high-flying equities plummeted.
After the dot-com bubble bust and stock market crisis, speculators fled to real estate. In response to the technology bust, the U.S. Federal Reserve lowered and maintained interest rates. This rush of money and credit met with government programs to encourage homeownership and financial market developments that improved real estate asset liquidity. More people bought and sold homes as home prices soared.
What Happened to Homeowners When The Housing Market Crashed?
In the next six years, the homeownership craze developed as interest rates fell and lending standards were relaxed. An increase in subprime borrowing began in 1999. Fannie Mae made a determined attempt to make home loans more accessible to borrowers with weaker credit scores and funds than are generally needed by lenders. The intention was to assist everyone in achieving the American dream of homeownership.
Since these customers were deemed high-risk, their mortgages had unconventional terms, such as higher interest rates and variable payments. In 2005 and 2006, 20% of mortgages went to persons who didn’t meet regular lending conditions. They were called Subprime borrowers. Subprime lending has a higher risk, given the lower credit rating of borrowers.
75% of subprime loans were adjustable-rate mortgages with low initial rates and a scheduled reset after two to three years. Government promotion of homeownership prompted banks to slash rates and credit criteria, sparking a house-buying frenzy that drove the median home price up 55% from 2000 to 2007. The US homeownership rate had increased to an all-time high of 69.2% in 2004.
During that same period, the stock market began to rebound, and by 2006 interest rates started to tick upward. Due to rising property prices, investors stopped buying homes because the risk premium was too great. Subprime lending was a major contributor to this increase in homeownership rates and in the overall demand for housing, which drove prices higher.
Borrowers who would not be able to make the higher payments once the initial grace period ended, were planning to refinance their mortgages after a year or two of appreciation. As a result of the depreciating housing prices, borrowers’ ability to refinance became more difficult. Borrowers who found themselves unable to escape higher monthly payments by refinancing began to default.
There was an increase in the number of foreclosures and properties available for sale as more borrowers defaulted on their mortgages. A drop in housing prices resulted, in lowering the equity of homeowners even more. Because of the fall in mortgage payments, the value of mortgage-backed securities dropped, which hurt banks’ overall value and health. The problem was rooted in this self-perpetuating cycle.
By September 2008, average US property prices had fallen by more than 20% since their peak in mid-2006. Because of the significant and unexpected drop in house values, many borrowers now have zero or negative equity in their houses, which means their properties are worth less than their mortgages. As of March 2008, an estimated 8.8 million borrowers – 10.8 percent of all homeowners – were underwater on their mortgages, a figure that is expected to have climbed to 12 million by November 2008.
By September 2010, 23 percent of all homes in the United States were worth less than the mortgage loan. Borrowers in this circumstance have the incentive to default on their mortgages because a mortgage is normally non-recourse debt backed by real estate. As foreclosure rates rise, so does the inventory of available homes for sale.
In 2007, the number of new residences sold was 26.4 percent lower than the previous year. The inventory of unsold new houses in January 2008 was 9.8 times the sales volume in December 2007, the highest value of this ratio since 1981. Furthermore, about four million existing residences were for sale, with around 2.2 million of them being unoccupied.
The inability of Homeowners To Make Their Mortgage Payments
The inability of homeowners to make their mortgage payments was primarily due to adjustable-rate mortgage resetting, borrowers overextending, predatory lending, and speculation. Once property prices began to collapse in 2006, record amounts of household debt accumulated over the decades. Consumers started paying off debt, which decreases their spending and slows the economy for a prolonged period of time until debt levels decreased.
Housing speculation using high levels of mortgage debt drove many investors with prime-quality mortgages to default and enter foreclosure on investment properties when housing prices fell. As prices fell, more homeowners faced default or foreclosure. House prices are projected to fall further until the inventory of unsold properties (an example of excess supply) returns to normal levels. According to a January 2011 estimate, property prices in the United States fell by 26 percent from their high in June 2006 to November 2010, more than the 25.9 percent decrease experienced during the Great Depression from 1928 to 1933.
There were roughly 4 million finalized foreclosures in the United States between September 2008 and September 2012. In September 2012, over 1.4 million properties, or 3.3 percent of all mortgaged homes, were in some stage of foreclosure, up from 1.5 million, or 3.5 percent, in September 2011. In September 2012, 57,000 houses went into foreclosure, down from 83,000 the previous September but still far over the 2000-2006 monthly average of 21,000 completed foreclosures.
A variety of voluntary private and government-administered or supported programs were implemented during 2007–2009 to assist homeowners with case-by-case mortgage assistance, to mitigate the foreclosure crisis engulfing the U.S. During late 2008, major banks and both Fannie Mae and Freddie Mac established moratoriums (delays) on foreclosures, to give homeowners time to work towards refinancing In 2009, over $75 billion of the package was specifically allocated to programs that help struggling homeowners. This program is referred to as the Homeowner Affordability and Stability Plan.
Is There a Housing Bubble?
When a new generation of homebuyers enters the market, housing bubbles often arise naturally as a result of population expansion. As a result of this expansion, the demand for housing is expected to rise. Speculators, excellent economic circumstances, low-interest rates, and a wide variety of financing alternatives are all elements that will lead to an increase in home values. Increased demand drives up costs because of the building time lag. Any time housing prices diverge significantly from demographically-based organic demand, the broader economy is at risk of entering a state of crisis.
The COVID-19 pandemic did not slow home prices at all. Instead, it skyrocketed. In September 2020, they were a record $226,800, according to the Case-Shiller Home Price Index. According to the National Association of Realtors, the sales rate hit 5.86 million houses in July 2020, rising to 6.86 million by October 2020, surpassing the pre-pandemic record. Many people were taking advantage of the low-interest rates to purchase either residential properties or income-based flats that appeared to be inexpensive.
Home prices rose 18.8% in 2021, according to the S&P CoreLogic Case-Shiller US National Home Price Index, the biggest increase in 34 years of data and substantially ahead of the 2020s 10.4% gain. The median home sales price was $346,900 in 2021, up 16.9% from 2020, and the highest on record going back to 1999, according to the National Association of Realtors. Home sales had the strongest year since 2006, with 6.12 million homes sold, up 8.5% from the year before.
As speculators entered the market, home prices skyrocketed, exacerbating the housing market bubble. Now it reaches a time when home prices are no longer affordable to buyers. Rising prices make properties unsustainable, causing them to be overpriced. In other words, pricing increases. Low inventory, fierce competition, and large price increases have harmed purchasers since 2020, but quickly rising mortgage rates are making it much more difficult to find an affordable house.
As prices become unsustainable and interest rates rise, purchasers withdraw. Borrowers are discouraged from taking out loans when interest rates rise. On the other side, house construction will be affected as well; costs will rise, and the market supply of housing will shrink as a result. In contrast to a sudden jump, a sustained rise in interest rates will inflict little damage on the housing market.
Rising rent costs and mortgage rates, which increased from an average of just 3.2% at the beginning of the year to 5.81 percent by mid-June, have increased the cost of housing, pricing many individuals out of the market. This has resulted in a decline in house sales since an increasing number of individuals are unable to buy homes at the present inflated prices. According to NAR, existing-home sales declined for the fourth consecutive month in May, falling 3.4% from April and 8.6% from the same period last year.
Given the relative scarcity of available homes, the majority of analysts concur that a decline in housing prices is improbable. In addition to rising mortgage rates and subsequently less demand, a downturn might exert downward pressure on home prices. Despite many similarities to the housing bubble of 2008, the present housing market is quite different from it.
Homeowners with mortgages are not at a high risk of default, housing values are mostly determined by supply and demand rather than speculation, and lending rates continue to rise. Accordingly, the concept of a housing market crash is deemed improbable by a number of industry professionals. Many analysts believe that sky-high mortgage rates and the associated drop in housing demand will moderate the increase of home prices rather than result in any significant reversal in prices or a crash, which is generally defined as a widespread drop in home prices.
However, in the event that a more widespread recession hits the economy of the United States, the conditions might be created for a little decline in housing values. A deeper and more widespread economic downturn is likely to prompt a greater number of homeowners to sell their homes than would be the case otherwise. Because of the rise in available inventory, housing prices could experience some leveling out as a result.
It is also possible that a recession may just serve to limit the increase of property values, which is what many people anticipate would happen if interest rates continue to climb. However, it is still challenging to bring prices down because there are only limited properties available for purchase. The number of people applying for mortgages has already dropped by more than 50 percent since this time last year. It is not unrealistic to foresee a further decline in home demand given the impending implementation of additional rate increases. This will serve to rebalance the housing market, which is now squeezed, but it won’t necessarily bring it to the point where it crashes.
References
- https://en.wikipedia.org/wiki/Subprime_mortgage_crisis#
- https://www.investopedia.com/articles/economics/09/subprime-market-2008.asp
- https://www.forbes.com/advisor/mortgages/real-estate/will-housing-market-crash/
- https://www.noradarealestate.com/blog/housing-prices/
- https://investorplace.com/2022/06/what-would-cause-the-housing-market-to-crash-in-2022/
- https://www.noradarealestate.com/blog/housing-market-predictions/
Almost as soon as home prices began their unprecedented climb in 2020, doomsayers began warning of a looming crisis. The housing market, they claimed, was a bubble destined to burst.
A litany of supposed catalysts was going to send prices into a tailspin: the “Airbnbust,” the sudden surge in mortgage rates, a flood of grifters and hucksters looking to make a quick buck in real estate. Bubble watchers forecast chaos, then sat back and waited. And waited. And waited.
I’ve spent the past few years asking experts a simple question: Has the housing market reached bubble territory? The answer remains a resounding no. More than three years after prices started to soar, the only thing that’s gone bust is the gloomy predictions. Despite some cooling in a handful of overheated markets such as Charlotte, North Carolina, and Austin, the median home-sale price increased by a respectable 4% nationwide in 2023, Redfin reported. The price for a typical home has risen by more than 47% since late 2019, according to the S&P CoreLogic Case-Shiller National Home Price Index, a closely watched measure of housing costs.
But maybe I’ve been posing the wrong question all along. The B-word implies an impending pop, a point when the combination of greedy speculation, unscrupulous behavior, and soaring prices brings everything crashing down. Barring a large-scale economic disaster, there’s no pop in sight.
The staggering jump in home prices is concerning, to be sure. But it’s a function of a severe lack of supply, not a byproduct of investors swarming the market or shady lenders artificially juicing demand. Those looking for parallels to 2008 are grasping at straws — homeowners are in far better financial shape than they were the last time prices cratered, and homebuilders, rather than flooding the market with new properties, aren’t keeping pace with the sheer volume of millennials suddenly consumed by dreams of backyards and picket fences.
So if you’ve been waiting — maybe even cheering — for prices to plummet: Don’t hold your breath.
Warning signs
A funny thing about bubbles is they don’t fall neatly into a single definition. Ask a dozen economists to sketch out their criteria, and you’ll probably get 12 different answers. But Mike Simonsen, the president of the housing research firm Altos Research, offered a useful way to think of a bubble’s life cycle in a post on X, formerly Twitter, late last year (which I’ve slightly paraphrased):
1. You got rich! Good for you! You did the hard work and got in early.
2. Hm. It seems like everyone is getting rich?
3. Wait. That asshole?! That guy is not smart, maybe even criminal.
4. Pop.
For a time, it seemed like the housing market was doing a speedrun through Simonsen’s checklist. There were the runaway prices: Before the pandemic, you could buy a median-price home in Las Vegas for about $281,300, according to Redfin. Good luck finding that kind of deal now — even with a dip from pandemic highs, the cost of a typical house there has swelled to $422,000, an eye-watering 50% increase. Similar stories have played out in Miami (70%), Boise, Idaho (40%), and Dallas (36%). The typical household would have to spend nearly 34% of its income to afford major homeownership expenses such as mortgage payments and property taxes, according to the data firm Attom, the highest percentage since 2007 and well beyond the 28% debt-to-income ratio that’s typically preferred by lenders.
Then there were the people getting rich. Speculators were using supercheap loans to buy homes, expecting to profit by selling to an even bigger fool; home flippers, aspiring megalandlords, and Airbnb owners flaunted their debt-funded miniempires on TikTok; and seemingly everyone was signing up to be a real-estate agent. Even usually buttoned-up real-estate professionals were giving off bubble vibes: High-flying mortgage companies threw lavish parties featuring bands such as Imagine Dragons, while Zillow, the ubiquitous home-search site, morphed into one of the country’s biggest homebuyers — even though its acquisition math didn’t add up.
All the signs seemed to point to a bubble, and there were plenty of people predicting the “pop” was coming: In late 2022, the prominent Wall Street economist Ian Shepherdson forecast home prices to fall by as much as 20% the following year. Goldman Sachs expected a more modest, but still significant, decline of up to 10% from the peak. Countless headlines wondered whether home values were set to crash. Even Federal Reserve Chair Jerome Powell, whose every word threatens to move markets, said at a Brookings Institution event in 2022 that housing was in a “bubble” during the pandemic, with “prices going up at very unsustainable levels.”
But there was no pop, no sudden collapse in home prices. Even with mortgage rates tripling and buyers retreating, values held up.
The gloomy oracles could even point to an instigator of the coming collapse. The Fed, led by Powell, began raising interest rates in spring 2022 to fight inflation, sending mortgage rates shooting upward. Mortgage rates kept rising through most of 2023, eventually reaching a 20-year high in October of nearly 8%, up from less than 3% during the depths of the pandemic in 2020 and 2021. Suddenly it wasn’t so cheap to borrow money, making it tougher for reckless investors to enter the market. Speculation is the oxygen for a market-frenzy fire, Rick Palacios Jr., the director of research and managing principal at John Burns Research and Consulting, told me. By hiking rates, the Fed cut off the air supply.
But there was no pop, no sudden collapse in home prices. Even with mortgage rates tripling and buyers retreating, values held up. To understand why, you have to look at the fundamentals — the deep-seated reasons all the “Bubble Boys,” doomsayers, and fear-mongering headlines are dead wrong.
Debunking the bubble
Rising prices, no matter how steep, aren’t enough to constitute a bubble. Prices also need to diverge from the fundamentals, or the basic components of supply and demand, that determine how much things cost. If the run-up in prices defies logical explanation or obscures sketchy business practices, watch out. In the years leading up to the global financial crisis, for instance, lenders came up with creative ways to boost demand: They devised predatory mortgages that left borrowers on the hook for impossibly high payments once their teaser rates expired and handed out so-called NINJA loans (no income, no job, and no assets). If you owned a home at that time, you might’ve felt like the only direction its value could go was up.
The recent housing-bubble theory was always going to age poorly because of one fact: The pandemic soaring prices were justified. Prices didn’t spiral out of control because we built too many homes or made it too easy to borrow money, like in 2008; they took off because there simply weren’t enough homes for all the creditworthy people who wanted to buy them.
It’s a savagely unhealthy housing market. But it’s also a market that just had too many people chasing too few homes.
For home prices to suddenly crash, there would have to be a pool of desperate sellers looking to offload their homes on the cheap — or, worse, losing them to the foreclosure process. Sure, speculators were loud and proud about their get-rich-quick schemes, but they were a vocal minority. And regular homeowners have “never looked this good” when it comes to their financial and credit health, Logan Mohtashami, the lead analyst at HousingWire and an outspoken critic of bubble alarmists, told me. Less than 4% of outstanding mortgages were delinquent at the end of the third quarter last year, according to the Mortgage Bankers Association, a near-record low. In the fourth quarter of 2023, the median credit score for people getting a new mortgage was a stellar 770, according to the Federal Reserve Bank of New York. (Lenders typically consider a score above 700 to be a marker of future success for a borrower.) Almost 79% of homeowners with a mortgage have locked in a rate below 5%, a Redfin analysis of data from the Federal Housing Finance Agency found. In the history of rates, that’s a pretty incredible deal. And nearly 40% of homeowners don’t even have to stress about mortgage payments at all, according to census data — they own their homes free and clear.
Rather than facing a housing bubble, we’re staring down an entirely different crisis: a supply shortage that has regular buyers fighting just to break into the market. US homebuilders spent the decade after the global financial crisis building at about half the rate of the three decades prior, contributing to the housing crunch. Various estimates have pegged the national housing shortage anywhere between 2 million and 6 million homes. The supply constraint hit right as millennials, the largest living generation in the US, reached their prime homebuying years. Add in people’s sudden desire for a bigger house or a place of their own in the heat of the pandemic, and the recent surge in home prices seems less bubbly and more logical. The lack of inventory is the reason prices didn’t suddenly drop, even when mortgage rates shot up. Sure, buyers pulled back. But sellers pulled back even more, leaving the supply-demand imbalance in place.
“It’s a savagely unhealthy housing market,” Mohtashami told me. “But it’s also a market that just had too many people chasing too few homes.”
Staying high
It’s tempting to look for echoes of 2008 in today’s housing market. You might even be inclined to cheer on a crash in prices — all the better for everyone who feels locked out of homeownership. But cycles rarely repeat in the same way, Selma Hepp, the chief economist at CoreLogic, told me. Anything that could incite a housing crash probably wouldn’t leave average consumers in a position to suddenly pounce on all that excess inventory.
Fannie Mae now projects a modest 3.2% increase in home prices this year and a jump in home sales, along with a decline in mortgage rates. Goldman Sachs predicts a 5% rise in home prices. John Burns Research and Consulting doesn’t publish an exact forecast of home prices, but Palacios told me the firm expected to see a similar increase in the “low single digits.”
Perhaps the biggest threat to the housing market at large is a severe economic slowdown, one in which many people lose their jobs and can’t pay their mortgages. It’s notoriously difficult to estimate where the economy is headed, but right now, it’s roaring along, especially compared with other rich countries. Things aren’t perfect, but the vibes are definitely up. And even if the economy does take a turn, a run-of-the-mill recession probably wouldn’t be enough to topple the housing market. Things would have to get so bad that banks would be forced to walk away from the mortgage-lending space almost entirely, as they did during the foreclosure crisis. If the market is cratering and nobody can get a mortgage to put a floor on prices, “that’s where you get pretty meaningful declines in asset prices,” Palacios said.
There’s a silver lining baked into all this: Prices aren’t poised to drop, but the days of skyrocketing valuations appear to be behind us, Mohtashami told me. The housing market is far from balanced, but we’re at least heading in that direction.
After the past few years, the lingering fears of a sudden fallout are just a distraction from the bigger issues at hand. The bubble debate was fun; now it’s time to put it to bed.
James Rodriguez is a senior reporter on Business Insider’s Discourse team.