![]() ![]() ![]() It is a cautionary tale of the horrific consequences of not checking home buyers’ potential to repay home loans. Perhaps the most infamous case of a housing bubble in recent memory is the 2007–08 housing market crash. However, it is easy to recognize them in hindsight once demand decreases, and the dust settles from the real estate industry and the larger economy. Housing bubbles are unique events prodded by economic and social complexities that are oftentimes too difficult to see as they take place. While these three factors are critical, they aren’t exclusive circumstances. When the mortgage lender’s incentive is to make money at any cost-including misleading customers and not performing due diligence-a housing bubble is more likely to occur.Įconomic stability, low interest and mortgage rates, and weak real estate lending standards all set the foundation for housing bubbles. This lack of lending standards was a hallmark of the real estate bubble that created the 2007-08 housing market crash. Seeing an opportunity to make money in the housing market, mortgage lenders engage in risky behavior such as predatory lending, giving loans to people without checking their ability to repay, and not educating customers on the nuances of complicated products like adjustable-rate mortgages. Housing bubbles typically evolve from substandard mortgage lending practices. 3.) Weak lending standards in real estate This pressure builds to create housing bubbles. As these people flood the real estate market, home prices rise, and additional people rush to join. Low interest rates set an economic baseline for a real estate bubble to occur: money is easier to attain, so people borrow it to finance their new house or make home improvements. In other words, loans are “cheap.” This affects the housing market as people seek mortgage lenders to borrow money at a lower cost than normal. People borrow more money when interest rates are low because it costs less. This means there is a clear human psychological element of excitement that feeds into producing real estate bubbles. When people have an optimistic outlook on their economic future, the societal effects are contagious: positivity begets positivity. Speculation exacerbates the speed at which the real estate bubble expands. The faster it flows, the more often it touches people excitedly looking to profit, such as speculative buyers. More spending means more cash flowing through the stock market and society at large. When people feel they’re on solid ground, they spend money. 1.) Economic stabilityĪlthough a housing bubble may not sound like a stable phenomenon, having disposable income certainly is. There is no single cause for a housing bubble to occur, but there are a few common factors that encourage it. Unfortunatley, when a housing bubble bursts, people can lose their homes and life savings. If this happens in our soap illustration, you’re just stuck in the bathtub out of breath, with soap all over your hand. There are too many homes at prices people are unwilling to pay, causing their own homes to lose value. When this happens at once, the bubble, unable to support itself, finally bursts. However, since these high home prices are no longer affordable to most people, demand suddenly decreases. Housing supply starts to catch up with demand. If too many people do this at the same time, the above-average price for homes rises faster than people can pay. Speculators, thrilled to make a profit, notice the upward trend and jump in on the action, driving home price appreciation to a breaking point. They then tell their friends, who spread the optimism and expectation of making money in real estate.Īs the news catches on, momentum drives people to further invest, as everyone believes their actions will pay dividends down the line. They are likely to see their (future) home as an investment, so they purchase a new house or make home improvements, thinking it will give them a nice financial return in the future. People become excited that their (future) property will increase in value because that means more money in their pockets. If more people seek housing than the housing market-the bubble-can provide, home prices-the air in the bubble-rise. If you blow too much air, the bubble can no longer support all the air inside, so eventually, it explodes. ![]() The more air you blow, the bigger it gets. ![]() You pour soap onto your palm, then blow on it, causing a small bubble to grow. ![]()
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