Housing Bubble

What is a housing bubble?

Updated March 14, 2022

A housing, or real estate, bubble occurs when home prices rise at a rapid pace, fueled by an increase in demand, limited supply and risky behavior by home buyers and speculators with unrealistic notions about how high prices will go.  

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These bubbles usually start with a jump in demand for housing in a real estate market with limited inventory. Speculators begin to pour money into the market, which further drives up demand. At some point in the bubble, the demand for housing decreases at the same time that supply increases, resulting in a sudden sharp drop in prices. And that’s when the housing bubble bursts. Investors start to pull out, decreasing the demand for housing and pushing down prices. The price drop scares off potential buyers, and current investors try to sell because they expect prices to continue to go lower, which pushes down prices even further.

A housing, or real estate, bubble occurs when home prices rise at a rapid race. Credit: Tumisu/Pixabay

After seeing consistent and rapid home price growth, many homeowners suddenly find themselves “underwater,” meaning they have borrowed more than their home is worth in the new post-bubble real estate market. This leads to a growth in foreclosures as banks try to recoup their money, further flooding the market with more housing and dropping home prices even lower. The U.S. experienced a major housing bubble in the mid-2000s caused by loose lending conditions, a major influx of money into the housing market and rampant speculation in a busy market. Then sharply rising home prices came to a sudden halt, values plummeted and millions of people lost their homes. 

How long do housing bubbles last?

Housing bubbles, like other asset price bubbles, are temporary events, but they can last for several months or even years. They tend to be less frequent than bubbles in financial markets, but they can last much longer. It’s often difficult to identify a housing bubble until it actually bursts.

An increase in demand for housing is caused by a range of factors and circumstances that can combine and feed off each other.

Variables include:

  • low interest rates
  • rising economic prosperity that puts more disposable income in consumers’ hands and encourages homeownership
  • easy access to credit that brings more buyers into the real estate market
  • new adjustable-rate mortgage products with low initial rates that make homes more affordable for a new segment of buyers
  • an increase in home flipping
  • new government programs that encourage homeownership
  • a lack of financial literacy and good long-term judgment about home appreciation rates by mortgage borrowers
  • speculative and risky behavior by investors and home buyers who have unrealistic estimates about how much home prices will continue to rise.

Similarly, the forces that cause a housing bubble to burst can happen simultaneously. These include:

  • a rise in interest rates that puts homeownership beyond the reach of some buyers
  • an increase in the supply of housing
  • a downturn in the overall economy that leads to less disposable income and more unemployment
  • a tightening of credit standards
  • a drop in demand for housing

Not only do housing bubbles result in a crash in the real estate market, they can have major consequences for the overall economy and the personal wealth of people across a range of classes and incomes. Sudden drops in the value and price of homes can force people to find new ways to pay off their mortgages, including dipping into savings and retirement accounts in order to avoid foreclosure and remain in their homes. Others will go bankrupt and lose their homes to foreclosure. These bubbles can also play a role in how neighborhoods look, with a sudden increase in foreclosures and abandoned properties falling into disrepair. In worst-case scenarios, housing bubbles lead to recessions.