A housing bubble occurs when property prices rise rapidly, causing inflation and wage increases to become unsustainable. Fiscal policies and supply and demand also play a role. Negative effects include increased foreclosures and higher unemployment rates. The bubble eventually bursts, causing property prices to fall and leading to foreclosures and job losses. A new housing bubble can form as buyers are lured back into the market.
A housing bubble occurs when property prices rise rapidly in a short amount of time. Inflation and wages often cannot keep up with rising property prices, which means that price increases eventually become unsustainable. Direct negative effects of a housing bubble include increased foreclosures, and indirect effects can include higher unemployment rates.
House prices, like all tradable commodities, are in part driven by supply and demand. When there are more buyers than homes for sale, competition among buyers leads to an increase in home prices. Many buyers knowingly overpay for real estate, believing that the longer they wait to buy, the more prices will rise. Buyers’ desire to participate in the housing market before homes become prohibitively expensive is a major driving force behind the typical housing bubble.
Fiscal policies designed to stimulate business spending can have the effect of creating or exacerbating a housing bubble. Central banks often cut interest rates to make borrowing cheaper for businesses, and these cost savings make it easier to expand and hire new staff. As businesses expand, more people can buy homes, and this causes an increase in demand for homes. Construction companies are not always able to build enough new homes quickly enough to meet this demand. Consequently, a housing bubble occurs.
When homes become prohibitively expensive, large numbers of people are unable to afford homes, and as a result, the supply of homes outstrips the demand. Existing homeowners are forced to sell their homes for below-market prices because they are otherwise unable to attract buyers. As a growing number of homeowners sell their homes for ever lower prices, the housing bubble is coming to an end. People who bought homes before the end of the bubble have mortgage balances that exceed their property values. These people cannot sell their homes unless they have enough savings to cover the excess debt.
People who cannot pay their mortgage before selling their homes often end up in foreclosure. A high number of foreclosures causes property prices to fall further. Investors lose money because of falling prices of securities linked to mortgages and real estate. As a result, investors have less money to spend, which means corporate profits fall and companies start cutting costs by laying off employees. Housing prices eventually fall so low that buyers are lured back into the market looking for deals, and as more people start buying real estate again, a new housing bubble starts to form.
Asset Smart.
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