What Is a Housing Bubble and Are We in One Now?

Today's low mortgage interest rates have been great for the housing market and first-time home buyers. Unfortunately, high buyer demand has caused prices to rise sharply, leading many people to wonder if we're living in another housing bubble.

The Great Recession isn't that far back in our collective memory. In the mid-2000s, sharply rising home prices came to a screeching halt. Values plummeted. Millions of people lost their homes. So when we hear experts toss around the phrase "housing bubble," it only makes sense to wonder if we're headed for another national financial crisis.

The jury is out, but most experts don't think we're in another housing bubble. The circumstances driving the housing market today are not the same as they were in 2007.

What is a housing bubble?

A housing bubble or real estate bubble happens when the market price of residential real estate sharply rises. This will happen when demand for homes exceeds the actual supply. The initial rise creates the expectation of future rises. That expectation attracts speculators who invest in the market, hoping to profit from the rising prices. This further increases demand and prices, causing the bubble to stretch and grow.

At some point, homes become overvalued and housing prices become unsustainable. Demand decreases, but the supply increases. Now, with fewer buyers, housing prices come crashing down and the housing bubble bursts.

What causes a housing bubble?

Housing bubbles are a combination of factors leading to high demand and steep price growth. You need a healthy economy, for one thing. When disposable income grows and people feel secure in their jobs, the urge to hit the streets and house shop grows.

Another factor is mortgage rates. Low rates drive up demand because mortgages become more affordable. In a real estate market where rates are low and house prices are on the rise, multiple buyers often race each other to nab each new listing. That drives prices up even more.

Relaxed mortgage lending guidelines can also play a part. In the housing bubble that led to the Great Recession, many lenders made loans to subprime borrowers who couldn't afford to repay them.

Add in speculators acting as investors in the housing market, causing real estate to become overvalued, and you have the makings of a housing bubble.

Are we in a housing bubble now?

Most experts don't believe we're in a housing bubble right now.

The housing market crash of 2008 was largely caused by predatory lending. Lenders made loans that borrowers could not afford to repay. In many cases, no documentation was required to prove that the borrower had enough income to afford the mortgage. Virtually anyone could get a home loan. These stated income loans are very different today, and risky mortgages are not so easy to get.

The current demand is not the result of easy lending. It is the result of the natural market forces of supply and demand. Experts believe new home construction will help ease demand in the near future.

So why do some people think we are in another housing bubble? One reason is because supply is short and prices are increasing faster than salaries. Another is that homes in much of the country are considered overvalued.

Plus, the number of natural disasters is rising just as fast as home prices. Some experts think we are one major event away from seeing major insurers go bust. And that could create a housing crisis.

For more on whether or not it's a good time to buy, check out our guide.

What to do if the housing bubble pops

Worried another housing crash is on the way?

If we are in a housing bubble, and the bubble pops, home values will crash. You may find your home isn't worth the amount you still owe. Being underwater could make it harder for you to sell and move without taking a loss.

The best thing you can do now is avoid getting stuck with a mortgage you can't afford. Before buying a home, use a mortgage calculator to help figure out how much you can afford.

Also, make sure to avoid risky loans. Mortgage lenders for first-time homebuyers can help walk you through the process and select an appropriate loan.

In the last housing market crash, most homeowners who were able to keep paying their monthly mortgage payments eventually saw their home value rise and their equity return.

Not everyone fared so well. Speculators who bought homes using interest-only loans figured the home's value would continue to rise and they'd gain equity as a result. The idea was that before the loan reset to a higher principal-plus-interest payment, they'd be able to refinance to a lower rate or sell the home. Unfortunately, when values crashed, some of these folks were unable to keep making payments. Adding insult to injury, they couldn't sell the home for the amount they owed.

If you're already a homeowner, consider a refinance loan while refinance rates are low. If there were to be a housing market crash, refinancing might become harder.

For those patient folks who wait to see what happens in 2021? If you do see the housing bubble burst, that may be a good time to buy a home. If home values fall sharply and interest rates remain low, you could buy at a lower cost than usual and invest in your future.

Still have questions?

Here are some other questions we've answered:

• What Is a Mortgage Pre-Approval Letter?
• Loan Estimates: Everything You Need to Know
• Conforming & Nonconforming Loans: Here's the Difference