In May 2023, tech mogul Elon Musk cast doubt on the health of the housing market by tweeting, “Commercial real estate is melting down fast. Home values next.”
After a year of unpredictable economic activity, Musk isn’t the only one worried about a potential housing market crash. A recent Newsweek poll found that 58% of respondents were very or fairly concerned about a possible market crash.
But despite the rumors and fears that have been circling, most housing experts and economists say there is little cause for concern. While home prices are in a slight decline, Redfin Chief Economist Daryl Fairweather told Forbes why he isn’t worried about a crash, saying, “Prices are still like 5% to 6% above where they were this time last year. They’re down from earlier this year, but they’re still above what they were last year, so I don’t think that qualifies as a crash.”
While experts’ housing market predictions suggest smooth sailing for the U.S. housing market, many current and future homeowners want to make sure they’re prepared for any scenario. In this article, we’ll explain how to recognize warning signs of danger in the housing market, how to protect yourself from the risk of a market crash, and what today’s housing market conditions mean for you.
- Despite recent economic volatility, housing market predictions suggest there won’t be a housing market crash in the near future.
- Warning signs of a real estate market crash include rapidly rising home values, an oversupply of properties, and risky lending practices.
- An upcoming housing market crash is unlikely due to safe lending practices, high amounts of homeowner equity, and an undersupply of homes.
When Will the Housing Market Crash?
Experts predict a housing market crash is unlikely in the near future. However, a housing market correction has already begun and is likely to continue. This correction means home prices may drop below the exorbitant heights they reached in 2021, but this drop will likely be subtle and slow and is a step toward a healthier, more sustainable market.
Wells Fargo analysts predict, “Even with a correction, our base case forecast has prices remaining above the average levels seen in 2021.”
According to Bright MLS Chief Economist Lisa Sturtevant, “Despite uncertainty in the economy and the housing market right now, there is little to suggest that the housing market is poised for a crash.”
What Are the Warning Signs of a Housing Market Crash?
A housing market crash can occur after a housing bubble has developed. A housing bubble is a period of rapid, unsustainable increase in home prices fueled by speculation and unrealistic optimism. A crash occurs when the bubble “pops,” meaning the optimism shifts to pessimism and home values plummet.
When a housing bubble is forming, there are several warning signs that can indicate the bubble may soon pop, causing a sudden and significant downturn in the housing market. Here’s what to watch out for:
Period of Rapidly Rising Home Values
When home prices rise very quickly, especially more than 5–10% per year, it signals the market may be overheating and a correction is coming. This often drives affordability down, and buyers may have to leave the area to purchase a home.
It’s important to note that quickly rising home values do not indicate an upcoming market crash on their own. Home values can rise as a result of income or population growth. Unless you see this warning sign alongside several others, this may not be cause for concern.
Leading up to the 2007–2008 housing crisis and Great Recession, homes prices rose consistently. In a 2008 Brookings Institution report on the origins of the financial crisis, the authors stated, “A bubble formed in the housing markets as home prices across the country increased each year from the mid-1990s to 2006, moving out of line with fundamentals like household income.”
Excessive speculation, where buyers are purchasing homes just to resell them quickly for a profit rather than to live in, artificially drives up home prices. Investors are overly optimistic, imagining they can pay any price and make a profit because values are rising so rapidly.
In 2007, Chief Executive of the National Association of Home Builders (NAHB) Jerry Howard explained how investors drove up home prices before the market crashed prior to the Great Recession. Investors were quickly buying and selling homes, creating an illusion of extreme demand for homes. Howard said, “For the first time that I can remember, you saw investors coming into the housing markets and trying to play it into almost like a day stock.”
During boom times, builders engage in excessive residential housing construction. If the oversupply of new homes cannot be absorbed by the market, builders must slash prices to sell inventory. This drives broader home prices down. An oversupply can also occur as a population is decreasing in size.
Generally, a 5–6 months’ supply of inventory is considered a healthy level of homes to be on the market. A larger amount than this is considered a surplus.
Between 2003 and 2006, 6.2 million new single-family homes were constructed, setting records year after year. The NAHB’s Jerry Howard told CNNMoney.com that he believed some builders had been too aggressive leading up to the housing crash, saying, “Economists were starting to say this is a cyclical business, and we are going to get into a downturn. But some guys were chasing the gold and pursuing the brass ring, and they didn’t heed the market warnings as quickly as they should have.”
Rising Interest Rates
When interest rates start rising quickly, it makes mortgages more expensive and can dampen demand in the housing market. This may trigger a downturn. Individuals with adjustable-rate mortgages may also find themselves unable to afford their new mortgage payments.
Though borrowers could obtain loans cheaply in the early 2000s, the federal reserve started raising rates in mid-2004. The federal interest rate went from 1.25% in June 2004 to 5.25% two years later. These rate hikes drove many homebuyers out of the market and made it difficult for many homeowners with adjustable-rate mortgages to make their payments, contributing to the surge in homeowners defaulting on their mortgages in the 2007–2008 housing crisis.
Risky Lending Practices
When the housing market is hot, risky mortgage types like subprime, zero-down, and adjustable-rate mortgages become more common. As prices drop, homeowners with zero-down mortgages find themselves with negative equity, meaning they owe more on the loan than their home is worth.
Risky lending often takes the majority of the blame for the 2007–2008 financial crisis. This is because it became increasingly common for banks to give loans to borrowers with poor credit scores or no income documentation. The Brookings Institute reports that in 2001, 85% of mortgages were given to borrowers with good credit or income documentation. But that number dropped to 64% in 2004, 56% in 2005, and 52% in 2006, meaning nearly half of loans in 2006 were at high risk of default.
Additionally, adjustable-rate mortgages became very common, and borrowers who did not have a down payment were encouraged to pay for their house using 100% credit. When home values dropped, and interest rates rose, these types of borrowers were left without many options for paying back their loans.
Are the Warning Signs of a Housing Market Crash Present in Today’s Market?
There’s a reason people have been sounding the alarm that a housing market crash is coming. We’ve recently seen a few warning signs that could signal a market crash. While a few warning signs don’t mean a housing market crash is guaranteed, it’s important to keep an eye on them. So here’s what we’ve seen:
- Period of rapid price increases: In 2020 and 2021, home prices rose more quickly than experts consider a healthy and sustainable rate. In 2020, the U.S. saw a 10.4% gain in prices, while in 2021, prices rose an astounding 18.8%, with certain areas like Phoenix, Miami, and Tampa hitting price increases of over 27%.
Despite the quick price increases, Len Kiefer, Deputy Chief Economist at Freddie Mac, believes home values will not see a sudden sharp decline. He recently told Forbes, “While house prices grew at record rates in 2021, the reason for the increase was not primarily speculation or credit expansion, but rather record-low mortgage rates and a fundamental shift in housing demand.”
- Rising interest rates: After historically low-interest rates in 2020 and 2021, the Fed enacted ten rate hikes over the course of roughly one year, taking the rate from near zero to over 5%. The combination of high home prices and high-interest rates has driven many buyers out of the market.
So is this cause for concern? While these warning signs shouldn’t be ignored, there are several factors suggesting we’re safe from experiencing another devastating housing market crash.
Signs We’re Not Headed Toward a Housing Market Crash
- Healthy lending practices: Lending standards are much healthier today than they were before the 2007–2008 financial crisis. Borrowers are required to show they have good credit and consistent income. Additionally, while roughly 34% of mortgages had adjustable rates in 2005, now under 5% have adjustable rates, meaning homeowners have a locked-in affordable mortgage payment, even as interest rates rise.
- Homeowners have strong equity: Because many lenders allowed borrowers to take out mortgages with zero down payment before the Great Recession when home values dropped, homeowners owed the bank more than they could sell the home for. Luckily, today, this practice is very uncommon. In fact, nearly half of mortgaged homes are considered “equity-rich,” meaning that the amount the homeowners owe the bank is less than half the property value.
- Undersupply of homes: After the Great Recession, construction of new homes slowed down and never caught back up to the level needed to meet population growth.
From 2007 to 2020, new housing starts never crossed the 1.5 million mark, which was widely estimated to be the average annual supply needed to meet target household demand in the 2010s. Today, experts estimate we have between 3.8 and 7.3 million fewer homes than needed.
Because the laws of supply and demand say that prices will increase when there is more demand than supply, home values are unlikely to drop significantly until the housing shortage is remedied.
Chief Economist at the National Association of Realtors Lawrence Yun explains, “We simply don’t have enough inventory. Will some markets see a price decline? Yes, “[But] with the supply not being there, the repeat of a 30 percent price decline is highly, highly unlikely.”
How to Protect Yourself From the Risk of a Housing Market Crash
Homeowners or potential homebuyers who want to be ready for a worst-case scenario can follow these strategies to ensure their investment stays safe in a real estate market crash:
- Hold your property for the long-term: Speculative buyers and fix-and-flip investors who aim to quickly buy and sell properties for a profit take on a high risk, especially during times of economic uncertainty. Avoid this type of risky real estate investing by using a long-term investment strategy. Long-term investors know they can weather market volatility because their pay-off will come years down the road.
- Buy within your budget: Don’t overstretch your finances to buy a home you can barely afford. Ensure your monthly mortgage payment, taxes, and expenses are within your budget.
- Avoid adjustable-rate mortgages: Though lenders may tempt you with initially low rates on an adjustable-rate mortgage, taking out this type of loan puts you at risk of defaulting. Lock in an interest rate today with a fixed-rate mortgage, and know that your monthly payments won’t go up, regardless of how the economy performs or how the Fed adjusts rates in the future.
- Keep an emergency fund: An emergency fund with cash equal to at least 6 months of expenses helps you pay your mortgage and bills even in a financial crisis like a job loss. This is crucial protection during a housing market downturn.
- Make a large down payment: Save enough money to put at least 20% down on your mortgage before buying a home. While some lenders will let you put down as little as 3–5%, holding such a small amount of equity puts you at risk of owing more than the value of your home during a housing market downturn.
Dealing With a Housing Market Correction
While a sudden market crash isn’t likely to hit the U.S. soon, prices are in slight decline as of Summer 2023. After the rapid rise of home values in 2021, particularly in some of the hottest real estate markets, experts believe this decline may be a correction of the market rather than a crash.
According to Macro Trends Advisors founding partner Mitch Roschelle, prices are still far above pre-pandemic levels and likely to stay there. He tells Fox Business, “[W]hat we’re doing is we’re giving back, perhaps at most, a third or a quarter of the gains that we realized. But that doesn’t help somebody who just bought a house at the top of the market and now has something that’s lost 10%.”
If you’re in a situation where your home has lost value since you bought it, here are some strategies to make sure you don’t get off track financially:
- Think long-term: Remember that housing isn’t an investment that’s meant to be sold quickly. Even if you overpaid in the short term, if you hold onto your real estate investment for decades, you will make a profit in the long run.
- Convert your property to a rental: Sometimes, job situations, a growing family, or unexpected events make it impossible to stay in the same house for years. But that doesn’t mean you have to sell your property. If you overpaid for a home, it’s critical not to sell too quickly. If you’re ready to move elsewhere, convert your property into a rental and earn passive income.
- Check your lender’s early repayment terms: Some lenders allow you to submit mortgage payments more than once a month and work toward early repayment. This decreases the amount of interest you’ll pay over time, which can offset the expense of overpaying for a home. While every lender has different terms regarding early repayment, it’s worth checking to see if you save money with this strategy.
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