Are We in a Housing Bubble?
Homeownership has become a major element in achieving the American Dream. The strong desire for homeownership continues to keep home values appreciating. The graph below tracks home price appreciation since the end of World War II:
If you look at how prices spiked prior to 2006, it looks a bit like the current spike in prices over the past two years. Which may lead some people to be concerned we’re about to see a similar fall in home values as we did when the bubble burst. Let’s look at what happened last time and what's happening today.
What Caused the Housing Crash 15 Years Ago?
Back in 2006, foreclosures flooded the market. That drove down home values dramatically. The two main reasons for the flood of foreclosures were:
Many purchasers were not truly qualified for the mortgage they obtained, which led to more homes turning into foreclosures
A number of homeowners cashed in the equity on their homes. When prices dropped, they found themselves in an underwater situation (where the home was worth less than the mortgage on the house). Many of these homeowners walked away from their homes, leading to more foreclosures. This lowered neighboring home values even more.
Why Today’s Real Estate Market Is Different
Here are two reasons today’s market is nothing like the one we experienced 15 years ago.
1. Today, Demand for Homeownership Is Real (Not Artificially Generated)
Running up to 2006, banks were creating artificial demand by lowering lending standards and making it easy for just about anyone to qualify for a home loan or refinance their current home. Today, purchasers and those refinancing a home face much higher standards from mortgage companies.
Data from the Urban Institute shows the amount of risk banks were willing to take on then as compared to now.
Leading up to the housing crash 15 years ago, lending institutions took on much greater risks in both the person and the mortgage product offered. That led to mass mortgage defaults, foreclosures, and falling prices.
Today lending standards are much stricter in the current lending environment. Purchasers can afford the mortgage they’re taking on, so there’s little concern about possible defaults.
2. People Are Not Using Their Homes as ATMs Like They Did in the Early 2000s
When prices were rapidly escalating in the early 2000s, many started to borrow against the equity in their homes to finance new cars, boats, and vacations. When prices started to fall, many of these homeowners were underwater, leading some to abandon their homes and ushered in the increased number of foreclosures.
Black Knight reports that tappable equity (the amount of equity available for homeowners to access before hitting a maximum 80% loan-to-value ratio, or LTV) has more than doubled compared to 2006 ($4.6 trillion to $9.9 trillion).
ATTOM Data Services also reveals that 41.9% of all mortgaged homes have at least 50% equity. These homeowners will not face an underwater situation even if prices dip slightly. Today, homeowners are much more cautious.
Bottom Line
To Summarize, the major reason for the housing crash 15 years ago was a tsunami of foreclosures. With much stricter mortgage standards and a historic level of homeowner equity, the fear of massive foreclosures impacting today’s market is not realistic.