Housing bubbles are characterized by steadily increasing property prices in economic situations where homeowners and speculators assume they will continue to rise, and might take equity loans based upon that assumption. This is not in itself a bubble, but is generally taken as such when the bubble bursts, and equity collapses.
Not only do those that had taken second mortgages suffer but so do those who have just purchased their homes. A property originally purchased for $200,000 can shoot up to $300,000 very quickly in a housing bubble, and when prices become unsustainable, can just as quickly shoot back down to $200,000.
While the seller makes a quick hundred grand, the buyer loses the same amount very rapidly. They must continue to pay their mortgage, but cannot sell their home until their home is worth more than what is still owed on the mortgage. The larger the down payment they made, the less time this will take.
Housing Bubbles and Negative Equity Issues
People can then find themselves owing more on their homes than their equity can cover, defined as being in negative equity. The major issue with negative equity is that such homes cannot be sold until the situation is resolved. A mortgage is a lien on real estate, and if that cannot be paid when the property is sold, then the property cannot be sold!
Such situations can lead to foreclosures and a collapse of the housing market which is what happened in 2008. The housing bubble which had built up over the previous few years was on the point of bursting. This was also associated with the offer of sub-prime mortgage derivatives on the stock exchange, with insufficient equity behind them in the event of foreclosure.
When the inevitable burst happened, there were insufficient funds to cover the derivatives and the financial crisis kicked off. That was not the sole reason, but was one of the major influences involved. There have been many other housing bubbles throughout history. A housing bubble tends to appear every 12-14 years and generally runs for about 2.5 years.
Effect of Speculative Property Buyers
One of the major causes of housing bubbles is speculative property purchasing. Buyers seeking appreciation of their properties tend to go for adjustable rate mortgages that enable them to purchase property with low or even zero initial repayments of the principal. The interest payment in the initial years can also be very low.
This enables buyers to significantly improve their buying power to purchase higher ticket properties with the best likelihood of rapid appreciation. If the housing bubble bursts then the speculator loses big time. So does the lender because foreclosure doesn’t give lenders their money back – everybody loses out and before we know it there is a nation-wide financial crisis.
So what are housing bubbles? They are financial conditions that are extremely difficult to foresee, and when the bubble bursts the effects can be felt worldwide. As we all know!