Tell Me The Truth. Are We In a Housing Bubble?

Americans fear housing bubbles for good reason: the last bubble nearly unraveled the global economy.

So naturally, the rise in home prices over the past few years got people wondering: are we in another housing bubble? If so, what would happen if the bubble collapsed?

Let’s take a look.

What Is A Housing Bubble?

First things first, what is a housing bubble? By definition, it’s when home prices are artificially high — too high to be supported by the demand for homes.

Price bubbles can form around any commodity, not just housing. It has happened with tulips, NFTs, and many more items throughout history.

Housing bubbles have a big impact

Housing bubbles are just like other bubbles but the dollar amounts make them substantial. Let’s say you bought a $450,000 home during a housing bubble. The bubble burst, leaving your home worth only $350,000.

You’d be looking at a $100,000 loss, and if you had taken out a mortgage to pay for the $450,000 home, you’re still making payments on a $450,000 home — even though you own a $350,000 home. Not good.

Calm and patient homeowners will wait this out. They understand home prices, even when they fall in the short term, still tend to increase in the long run. They prefer to wait out the market instead of losing money on a sale to someone else — allowing the new owner to feel like a genius when prices rebound.

What about homeowners who have to sell?

But what if the home doesn’t meet your family’s needs anymore? Or what if you have to move for work? Or what if you had invested in the home with the intention of selling it quickly, and you need to sell in order to pay off another property you financed temporarily?

Suddenly, the housing bubble has created a real problem: negative equity.

Negative equity means the home is worth less than its mortgage balance. Selling the home won’t generate enough profit to pay off the loan. In fact, unless you can come up with enough extra cash to close the mortgage loan, you probably can’t sell the home at all.

Faced with this dilemma back in 2008 and 2009, millions of Americans decided to walk away from their homes and let the bank foreclose, wreaking havoc on economic systems around the world. It wasn’t all the homeowners’ fault. Banks had been lending money recklessly, fueling the bubble.

Are We In Another Housing Bubble Now?

This brings us back to the original question: are we in a housing bubble now, in the mid-2020s? Are house prices, which were driven higher during the pandemic, artificially high today? Will they collapse soon?

Back in 2022, when historically low mortgage rates were driving a surge in demand for homes, the Dallas branch of the Federal Reserve warned about the potential for a new housing bubble. The warning cited the huge increase in house prices when compared to the low inflation in other parts of the economy.

What about economic conditions now?

However, our economy has changed since 2022. In 2023, the Fed sustained an aggressive campaign to raise interest rates. The higher rates lowered demand for homes, curbing the rise in home prices.

About the same time, inflation ignited, raising prices throughout the economy and closing the gap between home prices and other living expenses.

Anyone who lived through 2020 and the years following the pandemic knows there’s no guarantee about future economic conditions. But, current data show we are probably not in a housing bubble.

How do we know there’s no bubble?

Housing bubbles are unlikely to form when there is a healthy demand for housing. The U.S. Department of Housing and Urban Development’s annual comprehensive housing study projects a strong demand for homes through at least 2027. HUD analyzes the entire economy to reach its conclusions.

Why should you believe HUD analyzes data sufficiently? Because if there’s a housing crash coming, it really, really needs to know. Since HUD’s FHA loan program insures new mortgages, a housing bubble could cost the agency a lot of money and require a government bailout. The FHA has to reimburse lenders when borrowers walk away from their FHA loans.

Freddie Mac, which helps regulate the market for conventional loans, came to similar conclusions in its recent analysis of the housing market. Freddie also cited the healthy demand for houses as evidence that today’s prices reflect market conditions.

Comparing Now And Then: What’s Different From 2008?

Home prices rose quickly between 2005 and 2008, leading to the infamous housing bubble that wrecked the economy. Home prices also rose quickly between 2019 and 2023. For some casual market observers, this is enough evidence to claim we’re in a housing bubble now.

But, the National Association of Realtors says the similarities between the 2000s and the 2020s end with the price increases.

Perhaps the best argument against a housing bubble is that the industry has stricter lending rules than in 2008. Leading up to the housing meltdown, lenders approved loans for buyers who couldn’t afford them with all sorts of questionable loan types like no income, no job, no asset, or NINJA loans. Federal lending laws now require more careful underwriting. This has helped keep home purchase prices in line with market values.

Today’s housing market is different from previously in other ways, too:

• We have fewer houses available: Ironically, today’s low inventory stems, in part, from the 2008 collapse. Back then, builders quit building houses since so many houses were standing empty. Now, we have fewer homes on the market because of that building stoppage.

• We have more new homebuyers: Millennials, our largest segment of the population, are entering their prime homebuying years.

• We have low foreclosure rates: Today’s foreclosure rates are a fraction of those in 2008-2010, showing most homeowners are keeping up with payments. Low foreclosure rates also keep home inventories low.

• We have homeowners paying historically low rates: Homeowners who bought or refinanced in 2021 and 2022 locked in historically low rates, creating unusually low monthly payments they don’t want to give up by moving.

• We have lower unemployment: In the months before the 2008 housing bubble, the economy was already in a recession, with unemployment above 6%. Today’s rate is about 4%, meaning more people can enter the housing market.

All of these factors combined help sustain a healthy demand for homes. Demand for housing helps keep prices in line with market values, preventing a bubble from forming.

What Could Change To Create A New Housing Bubble?

In our dynamic economy, it’s never impossible for conditions to change enough to spark a housing bubble. We have to look back only a few years — to the historically low mortgage rates of 2021 and 2022 — to see how unexpected economic forces can change the housing market.

So, what could change this year, or next year, or the year after, to create a housing bubble?

Again, this answer depends on demand. If the economy changed enough — and quickly enough — to suddenly hollow out demand for housing, a bubble could form around the industry.

However, traditionally, such a drop in demand for housing accompanies a recession with high unemployment. In times like those, more people want to sell their homes, but fewer people can afford to buy, creating a surplus of homes on the market.

In this case, the housing bubble wouldn’t be a surprise, and the Fed would likely start to lower interest rates to help stimulate the market again before the bubble had a chance to take off.

Fluctuations In The Market Won’t Always Inflate A Bubble

Most current homeowners remember the 2008 housing crisis and its excruciatingly slow recovery. Understandably, they don’t want to live through a similar crisis, risking what’s likely their biggest investment.

But no investment, not even housing, guarantees a smooth ride. Prices for commodities fluctuate. Sometimes, when they increase, they have to correct themselves with a decrease.

Home prices in many markets rose too high too fast during the pandemic, but higher mortgage rates in 2023 and 2024 helped spark a correction. At the moment, it looks like prices are correcting themselves gradually without leaving a bubble in their wake.