Many people worry about the rising home prices of today causing a bubble that is ready to burst. While there may indeed be trouble brewing, real concerns are still quite far off.
There are many that are describing the current condition with the housing market a bubble, and perhaps an even bigger bubble than we saw burst in 2007. That one was perhaps the most notorious one ever, with many people losing their homes and many more seeing the equity that they have built up evaporate or even have them in the red.
Home equity is the difference between the market value of your home and how much you owe on your mortgage. Some may think that this only really matters when you sell, much like riding out a big loss with your investments, but even the value of investments matters sometimes, if you’re using them as collateral for a loan for instance.
People borrow money against the equity of their home a lot more, and having access to this borrowing can be very important indeed. People are very often saved from financial disaster by having the ability to refinance their home and add the loads of debt that they have accumulated onto their mortgage to allow them to continue to pay what they owe back without defaulting.
While bankers are eager to portray this debt restructuring as saving a lot of their clients and saving many more a lot of money, and we do need to take their advice with a grain of salt since they do benefit when they talk us into these things, very often these deals do save us, especially with those who have really overextended themselves and for whom this may be the only option to be saved from default.
Refinancing is actually a double-edged sword, which is something the banks won’t tell you, and the price we pay for freeing up cash when we refinance is pushing a lot of the financial burden forward. A good example of this would be with refinancing a car loan that you are paying $300 a month for, and while amortizing this debt over the life of your mortgage can be tempting and even necessary in some cases, you can end up paying even more interest this way, as well as still having the burden of making payments on it long after it finds its way to the graveyard.
Poor Budgeting is Behind a Lot of the Aftermath
It’s this extended burden that is the other side of the sword, because we are now left with having to deal with all the day to day stuff, day to day things that we failed to manage properly, plus a bigger mortgage payment to go along with it.
What people tend to do a lot is to budget based upon this lower payment, and if we never needed to borrow again, we’d probably be fine, but people who need refinancing tend to spend and borrow more than they should, because that’s how they got in this trouble in the first place. This overspending will often continue, and there’s only so much equity that you can use in your home, and once that is used up the clients are often left with no way out.
It’s not hard to see, therefore, how seeing home equity decline by way of a housing bubble bursting can end up inflicting a lot of pain on a lot of people, whether they are looking to consolidate debt or if they are looking to use this equity for things that they need, like home renovations for instance.
This issue is therefore even bigger than just lenders losing money from defaults, as it also causes a cascade of other credit issues, which reduces the money supply, as well as seeing us spend less of this equity on other things, and see the economy contract as a result.
As we can see though, the problems caused by equity crashes are to a large degree caused by people borrowing more than they should in the first place, and while not being able to be bailed out is a big problem, the excess borrowing that got them to the point where they need such a bailout is the real cause of this problem.
Anyone who remembers the last crash will be very familiar with how big a deal housing crashes can be, and even though financial institutions take the brunt of this, that in itself can cause far-reaching economic crises, and all the lost equity can affect homeowners pretty significant as well.
The Real Chances of the Bubble Bursting Soon
When we look at the prospects of this happening in our near future, we can’t just look at charts of home prices, even though some people actually do this. We’re up well over the peak that broke our backs in 2007, and that itself may worry some people, and this is exactly the reason why so many are calling our current situation a bubble and waiting for it to burst.
The 2007 situation was fairly unique though, due to the extent that demand for home ownership was so artificially inflated, with no many sub-prime deals out there, and especially ones that required equity to increase to even allow people to continue to meet their obligations.
We have far less of this now, so our risk level of a crash is actually a lot lower. We just didn’t put the brakes on very high-risk lending, we also saw the market flooded with foreclosures. When you reduce demand and increase supply quite a bit, prices must fall and may fall a lot depending on the extent of the net effect of this change in supply and demand.
Nowadays, we really don’t have these issues, to anywhere near the extent that we did during the last rise. This wave has been achieved much more naturally, but that doesn’t mean that there isn’t a real threat out there, even though it may a lesser threat than the bomb that got dropped on the market from the 2007 crash.
Today’s threat comes from the potential for interest rates to rise, and they only really need to go up to historical averages for this to hit home in a big way. With prices rising so much, people have dedicated a larger portion of their income to their mortgage payments, and there are a lot of people out there who really couldn’t stand to see their rates go up all that much before they would become squeezed too much.
This is especially a threat with people who haven’t locked up their rate for the life of the mortgage, like a lot of people do in the United States. Those who have adjustable rates are fully exposed to this risk though. In other countries, mortgage terms renew more frequently, every 5 years for instance, and seeing your payment balloon at renewal can be a pretty unpleasant thing indeed.
Rising interest rates have already taken the edge off of the rising housing market, where we’re now seeing prices run pretty flat. This is more to do with the decreasing affordability of a given mortgage, due to higher prices and higher interest costs, than current mortgages being unsustainable, but if we do get to the point where rates go high enough, we could see a lot more of both.
This is not on the horizon though, and that’s what the doomsayers tend to miss. Housing prices are nothing like the run-ups and falls that we have seen with cybercurrencies, or even with stocks, as the housing market is entirely based upon fundamentals, and not just changing waves of sentiment. These fundamental indicators are nowhere near the point where we should be alarmed or even too concerned.
We still need to exercise prudence when we enter into a mortgage, and especially allow for rates to move like they tend to do without placing our deal at risk. Perhaps we simply cannot manage this with the property we may have in mind, but it never should be about looking to squeak by now and hope things don’t go against us, and we should not be gambling this way with our homes.