Here's Why You Shouldn't Worry About a Housing Bubble

Are we in a housing bubble?

U.S. home values have increased by over 35% in the past two years, including a 20.9% increase over the past 12 months. On the chart of average sales price of houses sold, the line is considerably more steep than the run-up prior to the 2008 financial crisis. After home prices peaked in the first quarter of 2007, home prices plunged by 20%. 

It is easy to see similarities between what's happening in today's housing market and the 2007 housing market crisis that triggered the "Great Recession." In a recent Redfin survey, 77% of home buyers and 44% of real estate agents believe there's a housing bubble. However, there are many differences between today's housing market and the one from 15 years ago. Here is why experts believe you shouldn't worry about a housing bubble.

Low supply and high demand

Low interest rates, surging demand, and dwindling supply have led to the surge in home prices. The National Association of Realtors estimates that nearly 1 million renter households have been priced out of the housing market. As a result, the share of first-time home buyers has fallen to 26%, an eight-year low. 

On top of that, the number of entry-level homes  -- properties sized 1,400 square feet or less -- is at a five-decade low. Starter homes accounted for 40% of new construction in 1980. In 2020, they accounted for only 7% of new construction. As a result, home affordability has become a substantial issue. 

The pandemic, supply chain issues, and now the crisis in Ukraine has exacerbated home inventory by extending build timelines. It has also further increased material prices needed to build new homes. Compared to the 2008 financial crisis, the primary reason prices have dramatically increased is the low supply of available and new homes coupled with high demand.

Change in lending practices 

The primary driver of the run-up of housing prices in the mid-2000s was easy money and subprime lending practices. A Congressional commission found that the roots of the Great Recession was due to lenders making loans "that they knew borrowers could not afford and that could cause massive losses to investors in mortgage securities." 

They found that underwriters violated its already-loose lending standards by engaging in predatory lending, document fraud, and in some cases criminal behavior. A Senate investigation concluded that risky loans "were the fuel that ignited the financial crisis."

Since then, there is much more oversight in the housing industry. Adjustable-rate mortgage loans with balloon payments are much less common. It is much more difficult to speculate in the housing market today. Most mortgages today are 30-year mortgages with no risk of a large increase in payments with interest rate increases. 

Will housing prices come down?

There are signs of the housing market slowing down. After a record breaking year for home prices, home sales are starting to slow as mortgage rate increases and high housing prices impact demand. The Federal Reserve has raised interest rates three times this year and have said more interest rate hikes are likely to come later on this year to slow inflation. 

Homeownership is becoming more out of reach for many Americans as high interest rates collide with record prices. The housing market is expected to return to pre-pandemic inventory levels by 2024. Demand is still high and in periods of high inflation, homeownership is seen as a hedge against inflation. 

"Most existing homeowners are insulated from high mortgage rates, thanks to more than 90% of loans in the past several years being vanilla fixed-rate, fully amortizing mortgages," according to a paper published by Zillow. "That keeps people's current bills affordable, and will prevent a foreclosure wave like the one that helped cause the housing market to spin out of control and crash in 2008."