# Understanding Housing Bubbles: Causes, Effects, and Examples

## What Is a Housing Bubble?

A housing or real estate bubble is a run-up in housing prices. Typically, housing demand surges, leading to speculation in the market, followed by price increases that eventually burst. Manipulated demand in the face of limited supply can cause a housing bubble, as can speculation. This was the case in the 2000s housing bubble in the U.S. When that housing bubble burst, homeowners faced negative equity and foreclosure.

### Key Takeaways

*   Housing bubbles occur when home prices surge due to high demand, speculation, and exuberant spending, but collapse when demand falls and supply increases, leading to a significant drop in prices.
*   A combination of factors such as deregulated real estate financing, excess liquidity, and speculative investment can create conditions ripe for a housing bubble to form.
*   One of the major consequences of housing bubbles is negative equity, where homeowners owe more on their mortgages than the actual value of their homes, leading to potential foreclosure.
*   The U.S. housing bubble of the 2000s was exacerbated by subprime lending and adjustable-rate mortgages, which became unsustainable as interest rates reset and home prices began to fall.
*   Understanding the mechanics and effects of housing bubbles can help homeowners and investors make informed decisions and navigate the risks involved in the real estate market.

![Housing Bubble: When property prices rise rapidly off rampant demand and speculation to unsustainable levels.](https://www.investopedia.com/thmb/bEimutHr8ftm7-7o1mLoY6Au-38=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/housing_bubble.asp-final-0033d65311674d2f8d512248f7115297.png)

*During housing bubbles prices will run up to unsustainable levels. — Mira Norian / Investopedia*

## Key Factors Behind Housing Bubbles

A housing bubble can occur due to abnormal factors like manipulated demand, excess investment, or deregulated real estate markets.

These factors can cause home prices to become unsustainable, leading to an increase in demand versus supply. Housing markets aren't as prone to bubbles as other financial markets due to the large transaction and carrying costs associated with owning a house.

However, a rapid increase in the supply of credit leading to a combination of low-interest rates and a loosening of underwriting standards can bring borrowers into the market. A rise in interest rates and a tightening of credit standards can lessen demand, causing the housing bubble to burst.

## Impact of Housing Bubbles on Homeowners and the Economy

Housing bubbles impact both communities and the economy. They can force homeowners to look for ways to pay off mortgages through various programs or they may have them digging into [retirement accounts](https://www.investopedia.com/terms/i/ira.asp) to afford to continue living in their homes. A housing bubble can significantly cut into the [equity](https://www.investopedia.com/terms/e/equity.asp) in a home and homeowners often find that their mortgage balance is more than the value.

Homeowners may force [foreclosure](https://www.investopedia.com/terms/f/foreclosure.asp) once the value of the home plummets and the mortgage exceeds the equity. Foreclosure occurs when a lender attempts to recover the amount owed on a [defaulted loan](https://www.investopedia.com/terms/d/default2.asp) by taking ownership of the mortgaged property and selling it. Typically, default is triggered when a borrower misses monthly payments or fails to meet other terms in the mortgage document.

> **Important**
>
> "Negative equity" occurs when homeowners owe more on their mortgages than their homes are worth. These mortgages are considered “underwater” or “upside down,” affecting an individual's net worth and preventing homeowners from relocating until the market improves.

## A Look Back: The U.S. Housing Bubble of the 2000s

A U.S. housing bubble occurred following the [financial crisis of 2007-2008](https://www.investopedia.com/articles/economics/09/financial-crisis-review.asp). Following the [dot-com bubble](https://www.investopedia.com/terms/d/dotcom-bubble.asp) bursting in the 1990s, investors moved their money from start-up technology company stocks into real estate. The U.S. Federal Reserve cut interest rates to combat the mild recession that followed the technology bust and to assuage uncertainty following the World Trade Center attack of Sept. 11, 2001.

Government policies encouraged home buying, while innovations made real estate assets more liquid. Home prices rose as interest rates plummeted. It's estimated that 20% of mortgages in 2005 and 2006 went to buyers, known as subprime borrowers, who would not have been able to qualify under normal lending requirements. Over 75% of these subprime loans were [adjustable-rate](https://www.investopedia.com/terms/a/arm.asp) mortgages with low initial rates and scheduled resets after two to three years. 

The government’s encouragement of broad homeownership induced banks to lower their rates and lending requirements. This spurred a home-buying frenzy that drove the median sales price of homes up by 55% from 2000 to 2007. In 2007, adjustable-rate mortgages started resetting to higher rates as the economy slowed. Housing prices declined 19% from 2007 to 2009, [triggering a massive sell-off](https://www.investopedia.com/articles/07/housing_bubble.asp) in mortgage-backed securities.

> **Fast Fact**
>
> In 2023, the number of foreclosure filings in the United States was 357,062. In 2009 and 2010, during the housing bubble, foreclosures totaled over 2.8 million for each year.

## What Is a Speculator in Real Estate?

A speculator buys properties because they have reason to believe that the market or some factor in the economy will increase in value, sometimes in a short period. The goal is to "flip" the property and sell it as soon as this occurs, reaping a profit. Unlike a speculator, an investor anticipates more of a long-term profit due to factors other than or in addition to market volatility.

## What Is an Adjustable Rate Mortgage?

The interest rate on an adjustable-rate mortgage (ARM) can go up and down over time affecting a homebuyer's mortgage payment and causing it to increase or decrease periodically. Most ARMs have rate caps and other controls to prevent frequent, dramatic, and painful swings. The advantage of this type of mortgage is that the interest rate is typically less than that of a fixed-rate mortgage in the early years of the loan.

## What Is the Foreclosure Process?

Foreclosure rules can vary from state to state, but it's typically initiated because the homeowner has stopped making mortgage payments. The mortgage contract gives the lender a secured interest in the property, This provides the lender with a legal right to seize the property after giving proper notice to the homeowner and allowing them to cure the default. The lender will then sell the property to recoup some, if not all, of the money it loaned so the homeowner could initially buy the property.

## The Bottom Line

A housing bubble occurs when housing prices rapidly increase due to high demand, speculation, and limited supply, often fueled by easy access to credit and loose lending standards. When the bubble bursts, housing prices drop sharply, leading many homeowners to experience negative equity, where their homes are worth less than the outstanding mortgage balances. This can lead to foreclosure.

Housing bubbles can significantly impact the economy, which is what happened in the 2000s when mortgage-based derivatives, government policies, low interest rates, and a surge in subprime lending caused the bubble to burst. As speculation and risky loans like adjustable-rate mortgages (ARMs) drove up the demand for housing, more and more homeowners were affected, making it harder for them to make their mortgage payments.  

> **Article Sources**
>
> 1.  Office of Policy & Research. "[Negative Equity in the United States](https://www.huduser.gov/portal/pdredge/pdr_edge_research_072012.html)."
>     
> 2.  Board of Governors of the Federal Reserve System. "[Open Market Operations Archive](https://www.federalreserve.gov/monetarypolicy/openmarket_archive.htm)."
>     
> 3.  Joint Center for Housing Studies of Harvard University. "[The State of the Nation's Housing 2008](https://www.jchs.harvard.edu/sites/default/files/son2008.pdf)," Page 2.
>     
> 4.  Board of Governors of the Federal Reserve System. "[The Rise in Mortgage Defaults](https://www.federalreserve.gov/pubs/feds/2008/200859/200859pap.pdf)," Page 5.
>     
> 5.  U.S. Financial Crisis Inquiry Commission. "[Financial Crisis Inquiry Report](https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf)," Pages 84-92.
>     
> 6.  Federal Reserve Bank of St. Louis. "[Median Sales Price of Houses Sold for the United States](https://fred.stlouisfed.org/series/MSPUS)."
>     
> 7.  ATTOM. "[U.S. Foreclosure Activity Increases From 2022 But Still Below Pre-Pandemic Levels](https://www.attomdata.com/news/market-trends/foreclosures/attom-2023-year-end-u-s-foreclosure-market-report/)."
>     
> 8.  University of Minnesota. "[Real Estate Speculation](https://create.umn.edu/wp-content/uploads/2020/02/Real-Estate-Speculation.pdf)," Page 1.
>     
> 9.  U.S. Department of Housing and Urban Development. "[Adjustable Rate Mortgages (ARM)](https://www.hud.gov/program_offices/housing/sfh/ins/203armt#:~:text=An%20ARM%20is%20an%20Adjustable,an%20ARM%20will%20change%20periodically.)."
>     
> 10.  Federal Housing Finance Agency. "[An Overview of the Home Foreclosure Process](https://www.fhfaoig.gov/Content/Files/SAR%20Home%20Foreclosure%20Process.pdf)," Pages 2-3.