Understanding Housing Bubbles

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James Britton CFP, CLU, EPC

Financial Planner
Britton Wealth Management and Planning Consultants Inc.
Fax : 866-202-2935

Housing bubbles can be devastating. Just look to the one in the late aughts, which saw millions of Americans enter foreclosure, losing their homes and much of their wealth in the process.

Want to prevent the same from happening to you? Then understanding housing bubbles (and when they might burst) is critical. Here's what to know about this market phenomenon — and the signs that might indicate whether we're in one right now.

What is a housing bubble?

A housing bubble is a steep run-up in home prices. It's defined by its ability to "pop." Eventually, whatever is driving demand will collapse, and suddenly there is no demand, which means that housing prices will begin dropping rapidly. 

There is no one cause for a housing bubble (it varies from bubble to bubble). However, they're always caused when the housing market moves away from the fundamentals that it's based on, usually by some temporary external pressure on the housing market that boosts demand. Here's a look at the conditions that typically lead to a housing bubble.


Speculation in the housing market can make a housing market crash worse after a bubble pops. Alyssa Powell/Insider

Rapid rise in home prices 

A housing bubble is primarily marked by a sharp price increase in prices in the real estate market. 

According to Logan Mohtashami, lead analyst at Housing Wire, housing bubbles occur when "prices are disconnected from fundamentals, and the demand that's being pushed by housing is of a speculative nature." 

Let's take an example: the housing bubble in the mid-2000s. At that time, lending standards were incredibly slack, and it was easy to get a housing loan, which created unsustainable demand for housing. When credit standards tightened, demand shrunk and prices fell.

Speculative buying and FOMO

Speculation can further drive the housing market away from fundamentals, though it doesn't have the force to create a housing bubble on its own. 

When real estate prices start climbing, speculators might see an opportunity to ride that wave and buy into the real estate market. These property investors limit the housing supply and raise prices even higher and further away from the fundamentals. 

Unsustainable demand

High demand leads to a run-up in prices and often encourages more housing construction. While that's good for satisfying demand at the time, once that demand eventually wanes — as it always does — it makes the subsequent crash even worse.

There is then a glut of supply and not enough buyers, leading to even steeper declines in home prices.

Signs of a housing bubble

There are typically signs you can watch for that indicate a housing bubble may be happening — or is at least in the works. These include:

Skyrocketing prices outpacing income growth

One concerning indicator is if housing prices are rapidly outpacing income. Housing demand grows when income grows because people have more disposable money to put toward a down payment on a house. 

If income isn't growing but housing prices are, then something else other than buying power is pushing demand. That could mean a housing bubble is afoot.

Loosening lending standards

Looser lending standards can also be a big red flag. The housing bubble that crashed housing prices in the 2000s, for example, was largely a result of loose lending practices — or what Mohtashami calls exotic loan debt structures. 

These risky loans were given to borrowers who wouldn't have been able to buy a house otherwise, opening the possibility of home ownership to a whole section of the population. Unfortunately, many of these borrowers were unable to make their mortgage payments, so they lost their homes as credit standards tightened.

"We no longer have any exotic loan debt structures in the system," Mohtashami says. "Hence, we have created the best homeowner loan profiles ever in our history."

Increased construction activity

A jump in home construction can also be a sign of a housing bubble. As demand increases, builders increase construction to capitalize on it. 

If they overbuild, though — or demand falls off quickly — that upsets the balance, ultimately driving home prices downward.

How housing bubbles burst

Compared to other economic bubbles, housing bubbles are uncommon. This is primarily because housing is so expensive, so it's not subject to a great deal of impulsiveness. 

When they do burst, though, the consequences can be huge and far-reaching. Here's how this typically happens and what it means for consumers. 

Triggers (interest rate hikes, economic downturns)

Anything that would hurt demand can trigger a housing bubble to burst. Rising mortgage interest rates, for example, could be a trigger, as they make buying a home more expensive and may discourage buyers from entering the market.

General downturns in the economy, widespread layoffs in one industry or market, or other issues can trigger a burst, too. 

Price corrections and falling demand

A housing bubble pops when whatever was pushing demand suddenly evaporates. Signs of a housing bubble bursting include a sudden abundance of supply compared to demand, exacerbated by both speculation and new houses on the market. 

"That causes a drop in home prices because people are willing to sell their home for lower and lower. Eventually, demand and supply reach an equilibrium," says Nik Shah, founder of Home.LLC. 

When a housing bubble pops, the general consensus is that if you're able to hold onto your house, you should wait to sell it until after the market has stabilized.

Foreclosures and economic impact

When a housing bubble bursts, the aftershocks can be huge. In the mid-2000s, it caused millions of Americans to lose their homes. Foreclosures doubled from nearly 720,000 in 2006 to 2.3 million in 2008. Six trillion dollars in wealth was lost as a result.

These losses reverberate throughout the economy, leading to less consumer spending and increased layoffs and unemployment. 


Are we in a housing bubble now?

Is the housing market going to crash? It's impossible to predict — though not likely anytime soon. While home prices have risen quite a bit in the past few years, demand is still much higher than supply. This keeps prices from crashing. 

Can a housing bubble crash the economy?

When a housing bubble bursts, it can have ripple effects on the broader economy. Spending typically falls, and as a result, companies lay off workers and unemployment rises.

How can I protect myself during a housing bubble?

To protect yourself should a bubble ever burst, always buy within your means and avoid taking on excessive debt. And if housing does crash while you own a home, keep up with your payments and avoid selling unless you absolutely need to. In this scenario, selling may leave you upside down on your mortgage — owing more on the home than you can get for it on the current market.

Who benefits from a housing bubble?

If you buy early in the bubble and then sell your house at the peak, before the bubble can burst, you may be able to net a significant profit from your investment. With that said, though, timing a real estate purchase this perfectly can be challenging, as it's not always clear if a housing bubble is in the works.

Can you predict when a housing bubble will burst?

There's no way to predict when a housing bubble will burst perfectly, but there are signs you can watch for. These include home price growth that exceeds income growth, increasing home construction, and loosening lending standards. 

How does a housing bubble form?

A housing bubble forms when home prices rise steeply, often faster than incomes can keep up. SIgns of a housing bubble include loosening lending standards, increased construction, and higher home prices.

What's the difference between a housing bubble vs. a normal market?

A housing bubble is when home prices rise rapidly due to some external force driving up demand. In the mid-2000s, a housing bubble was created when mortgage lenders loosened standards, allowing less creditworthy borrowers to buy homes. This is just one of several examples of housing bubbles in U.S. history. 

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James Britton CFP, CLU, EPC profile photo

James Britton CFP, CLU, EPC

Financial Planner
Britton Wealth Management and Planning Consultants Inc.
Fax : 866-202-2935