What is a housing bubble?

How supply and demand affect the housing market

A housing bubble occurs when the price of homes increase quickly over a short period of time. It’s sometimes referred to as a real estate bubble. Although housing bubbles are a temporary condition, they can last several years and make homes in affected communities more expensive to buy.

Housing bubbles can affect more than homebuyers and sellers. When housing bubbles burst, they can leave homeowners who bought their homes at the top of the bubble with large principal mortgage balances, relative to the value of their home. In some cases, homeowners might end up owing more on their mortgage than the home is worth (this is also called "being underwater on a mortgage").

What causes a housing bubble?

Housing bubbles can be caused by several factors. A rapid increase in demand, especially in communities where demand for housing is much higher than supply, can lead to a bubble.

Investor speculation in a real estate market often fuels a bubble. Investors are people or companies who are buying the house primarily as an asset, not as a place to live. Investors speculate that the housing market is "hot" and buy up homes in the hopes of making a profit. This includes people looking to flip homes, as well as those who are trying to make additional income with an investment or rental property. These investors may be willing to pay high prices for homes because they believe home prices will continue to rise. That is, they think a house that sells for a high price today will sell for an even higher price in a year or two—and that they can find a buyer who is willing to pay that higher price.

A good economy, low unemployment, and low interest rates can also contribute to a housing bubble. If the economy is growing and people are confident with their finances, they’re more inclined to invest their money in a home. If interest rates are low, homebuyers can spend less on interest payments and more on the home that they are buying.

As homes are purchased in days instead of months, supply decreases, and the “fear of missing out” fuels demand, leading to increases in the price of homes. This cycle continues, repeats, and, long term, is unsustainable. Then, the bubble bursts.

What happens if a housing bubble bursts?

When the supply of homes catches up to the demand in the market, or the economy changes, the housing bubble can burst, and home prices can drop, like they did in 2008. Falling prices, combined with less demand, can make buying houses less attractive to investors, too.

When prices drop suddenly, homeowners learn that they have less equity in their homes than they expected. Homeowners hoping to resell their homes and move must postpone their plans until home values start to go back up. Similarly, homeowners seeking a cash out refinance find that they receive less cash from their home equity.

How can you tell if there is a housing bubble?

It can be difficult to tell when a housing bubble exists in the community where you want to buy a house. It can also be difficult to predict when—or if—a bubble in housing prices might burst.

The decision to buy a home should be based, not on market conditions, but on your life circumstances. If you’re looking for a home and are concerned about inflated home prices, start with your goals and focus on what you can afford. Our mortgage calculator is a great tool that will give you an estimate of how much home you can afford and what your monthly payment might be. Our calculator includes interest, tax, and mortgage insurance, in addition to paying your principal balance.

This estimate can help you decide how much you can comfortably spend on a home. Consider this price, the reasons why you are buying the home, how long you plan to own the home, and the big picture of your finances when you are making a decision to buy.

Has the housing market burst before?

Yes, this happened most recently in the mid-to-late 2000s. Loose standards and a lack of oversight in the banking industry resulted in many people taking out mortgages that they couldn’t truly afford. This, combined with low interest rates for homeowners with adjustable-rate mortgages that reset to higher interest rates, meant that many people defaulted on their mortgages, since they could no longer afford their monthly mortgage payment.

Since then, the government put in place measures to lower the risk for both lenders and borrowers with stricter regulations on lending. These stricter requirements can make it harder to qualify for a mortgage, but they also ensure that the mortgage you might get is affordable for you!

Last reviewed and updated February 2024 by Freedom Mortgage