Two years ago, your coworker bought a house in your same neighborhood at a steal price. This year, you decided to jump into the house-hunting game… and discovered that a similar house would cost 20 percent more.
Yikes! With property values rising so quickly in many parts of the nation, are we on the cusp of another housing bubble?
In one word: no. In fact, we are far, far away from bubble territory. Below Trulia shares a few housing bubble basics showing why we’re a long shot from the next housing bubble.
What’s a Bubble?
Let’s start this explanation with the basics: What’s a housing bubble?
A “bubble” is an unsustainable rise in prices, often fueled by speculation and lending. It’s characterized by easy credit, irrational exuberance, and a rapid rise in prices.
Bubbles can affect housing, commodities like gold or copper, or the overall stock market as a whole.
What Caused the Last Bubble?
Several factors contributed to the last housing bubble, including:
#1: Loose Lending Standards
During the last bubble, financial institutions lent money to anyone with a pulse. (That’s only a half-joke). The criteria, or standard, that borrowers needed to meet in order to qualify for a loan was a very low bar.
For example: Many institutions didn’t require borrowers to prove their income. The borrower would self-report their income (write down a number), and the lender did nothing to independently verify whether or not this number was accurate.
What happened? People borrowed more than they should — often on adjustable-rate mortgages, which had low introductory teaser payments, followed by higher payments several years down the road. Eventually, they couldn’t make their payments, which led to foreclosure. Ultimately, when this happens to a large population of homeowners, it depresses housing prices.
Many people assumed that houses will always rise in value. As a result, a rush of builders and developers rushed to create new construction, glutting the market with inventory.
How did the developers pay for this construction? With loans, of course.
Banks issued loans to builders, who created massive inventory, and also issued loans to individual buyers, who gobbled up that inventory.
As a result, builders began over-leveraging. Developers would borrow massive amounts of money to build homes “on spec,” with the assumption that demand would never cease.
And for awhile, they were right. Buyers, who assumed house prices would rise forever, and who easily qualified for mortgages, eagerly bought houses. This fueled builder’s enthusiasm. And the self-reinforcing cycle continued — all built on a foundation of easy credit, and an assumption that prices would keep on rising.
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