As housing prices rise, many are wondering if we are nearing another housing bubble and subsequent crash. In short, I don’t believe we are, and there are several reasons for that. Let’s start with what happened 13 years ago.
Back in 2008 we experienced a housing market crash due to predatory private mortgage lending and unregulated markets. Demand for mortgages led to an asset bubble in housing. I was in the banking industry from 2005 – 2009 and witnessed firsthand the biggest financial collapse since the Great Depression. Here are just a few of the crazy products that were being offered to clients during that time:
- A borrower could walk in and request a $250,000 line on credit on their home. As long as the borrower had a good credit score and there was equity in the home, their income wasn’t verified but “stated”, and the bank gave them the line of credit. This was based on the idea that everyone had equity in their home – but that was a false assumption. This lending practice worked as long as the pie-in-the-sky home values continued to soar, which everyone thought they would.
- The second product our bank had was a pick-a-pay mortgage. On a purchase or refinance, the borrower had the option to choose what payment they wanted to make. Their choices: the common 30 year principal and interest payment, an accelerated 15 year principal and interest payment, interest only (the loan balance didn’t decrease), or negative amortization payment (since they weren’t paying even the interest, the mortgage balance ACTUALLY INCREASED). Borrowers weren’t educated on the ramifications and often chose the lowest payment option (negative amortization). Dangerous!
- Another product was the 3, 5, and 7 year adjustable rate mortgages. These products are still in use today but with better education of the borrower. In the mid 2000s, these were attractive to borrowers because the intro interest rate was so low and it would only adjust after the intro term expired. Lenders did not explain the ramifications and the borrower did not do their due diligence. Well, when home values began to crash in late 2007/2008, those mortgage adjustments meant people were stuck in their homes and under water on the home values. They couldn’t refinance and they couldn’t afford the higher payment. Suddenly, short sales and foreclosures became a plague in America.
Everything was out of control in 2008. Everyone was to blame: Predatory lenders, naive buyers, reckless regulators, and greedy investors. All of this caused the tower to crumble in 2008. If you haven’t seen The Big Short, stream it because it will give you great insight into why the housing market collapsed in 2008.
So how is this different than today? Housing prices still seem to be increasing dramatically and no one wants to overpay if a crash is looming. Let us put those worries to rest and explain 6 reasons why I believe we are not in a housing bubble. (source: Keeping Current Matters)
1. Mortgage standards are nothing like they used to be. During the housing bubble, it was easy for potential home buyers not to get a mortgage. This is no longer the case. The Urban Institute, which measures the percentage of owner occupied home purchases stated that we have much tighter lending standards and their level of risk is under 5%. Lenders have a low risk tolerance and they don’t speculate like they once did. This is the lowest it has ever been since the introduction of the index.
2. Prices are not soaring out of control. The annual home price appreciation rate averaged around 10% leading up to the recession of the bubble in 2008. Leading up to 2020, it has been close to 6%. While the appreciation is strong, it is nothing like the years leading up to 2008. This helps us believe that we are not repeating the housing market crash.
3. We don’t have a surplus of homes on the market. We are experiencing a shortage. Leading up to the market crash, the months’ inventory of existing single-family homes for sale averaged around 6 and was steadily increasing. Here in 2020, the months’ supply is decreasing causing the prices to go up.
4. New construction is not making up the difference in the housing shortage. Some people may think that new construction should fill in the void. However if you compare that to right before the housing market crashed, you can see that the overabundance of newly built homes was a major challenge then. But it isn’t now. The years leading up to 2008, there were 4 consecutive years of a record setting number of new homes being built. Over the last ten years we’ve been below the 50 year average. This is not what we experienced during the years leading up to the crash.
5. Lower mortgage interest rates and rising incomes correspond with higher housing prices as home buyers can afford to borrow and buy more. If housing is appropriately valued, house-buying power should equal or outpace the median sale price of a home. Looking back at the bubble years, house prices exceeded house-buying power in 2006, but today house-buying power is nearly twice as high as the median sales price nationally.
6. People are equity rich, but not tapped out. In the run-up to the housing bubble, homeowners were using their homes as personal ATM machines. They paid off debt only to get in more debt and they used false equity to buy secondary and investment properties. In recent years, prices have risen nicely over the last few years, leading to over 50% of homes in the country having greater than 50% equity—and owners have not been tapping into it like the last time. Here’s a table comparing the equity withdrawal over the last three years compared to 2005, 2006, and 2007. Homeowners have cashed out almost $500 billion dollars less than before.
This past year, real estate truly was fantastic despite the state of the country. It was surprising yet monumental. This exuberance has continued into 2021, which is why you can be confident in selling your home this year, and buyers can have some assurance that home values should continue steadily.
No one has a crystal ball to truly know what will happen in the future. Unforeseen factors could come into play that affect housing prices positively or negatively. Yet, I believe we can be confident that conditions today are different than they were in 2008 and we should not see a housing market crash like we did back then. Northern Virginia has always been somewhat insulated, due to the government and other industry’s drawing people to live here, and I don’t see that changing anytime soon. If you are worried about making a rash decision, talk with us because we want to help alleviate your concerns.
Image Source: Keeping Current Matters