Articles, Crash, Housing

What Happens When The Housing Market Crashes?

Written By: Rose Morrison
Reviewed by: Mike Reyes
Last Updated February 27, 2023
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Houses Near Road

The housing market is going through a rough patch, with fixed mortgage rates exceeding 7% compared to just 3% in 2020. Inflation has also made many houses unaffordable to the average buyer. The looming risk of an economic recession is another sign that a crash might happen soon.

What happens if and when the housing market crashes? Should homeowners and real estate investors be concerned? Here’s everything people need to know about the most likely outcomes of a crash.

Is the Housing Market Going to Crash?

Nobody knows the fate of the housing market for certain, but a few factors suggest a crash might be on the horizon. Home prices have been steadily rising and outpacing wage growth since early 2021. The market cannot sustain these numbers indefinitely, so something has to give.

Additionally, labor shortages in the construction industry and supply chain deficiencies have led to a housing crisis and reduced the options for homebuyers. The number of homes the United States is building cannot keep up with its population growth. 

Interest rates, inflation and other economic factors also pose increasingly dangerous threats to the housing market. Millions of low to average-income prospective buyers cannot afford to relocate or take out a loan. 

However, it’s still far too early to say a market crash will occur definitively. Diving deeper into these factors is best to see what’s hiding below the surface.

Home Inventory

Home inventory — the number of homes available for purchase — is one of the key metrics in determining the housing market’s future. Right now, the market is desperately undersupplied. Although inventory has risen by 13% since last year, it is nowhere close to pre-pandemic levels. The number of active listings was 625,875 in January 2023. 

Millions of Americans are ready to buy a home at any moment, so the current inventory isn’t nearly enough. However, a low market supply means more buyer competition. Although options are limited, the market still has lots of demand, which reduces the likelihood of a nationwide crash.

Building Demand

Building demand — the number of new homes being built — is also insufficient. America is short by 5 million homes, according to some estimates. This factor has little to do with the housing market itself. The great resignation saw millions of employees leave the construction industry, and essential materials like lumber and steel are more difficult to obtain due to supply chain issues.

As a result of the lack of building demand, housing prices have skyrocketed as real estate companies try to keep their limited inventories profitable. Prices have to increase when there are more buyers than available homes.

The only solution is to find faster and more efficient ways to build housing. Emerging technologies like modular building and 3D-printed homes could play crucial roles in rebalancing the supply and demand for housing. A market crash is a real possibility as long as demand stays low.

Population Growth

The United States’ rapid population growth has led to new demographic trends in the housing market. Gen Z is coming of age and immigration is up, ensuring consistent market activity in the coming years. Millennials are also in their prime years for real estate investments, so there’s certainly no shortage of buyers.

The most influential demographic is the growing Hispanic population, which accounts for the largest percentage of household growth in the next 15 years. Although there’s a lack of building demand, there are no concerns about the lack of interest in the housing market. Market conditions have made homebuying financially unrealistic for most people.

Lending Standards

Most homebuyers require loans to pay off their mortgages. That’s why lending standards — or lack thereof — play a crucial role in the housing market’s stability. Strict standards prevent the market from becoming hyperactive and keep prices reasonable.

Relaxed lending standards make it easier for buyers to get home financing. This sounds good, but it leads to an unsustainable housing bubble and drives up prices. This exact scenario played out during the 2007-2009 financial crisis, when mortgage fraud and “liar loans” wreaked havoc on the economy. 

Lending standards in 2023 still lean toward the strict side, meaning there’s little risk of a price increase due to unearned buying power. Despite high prices and interest rates, lenders are doing their best to keep the market from boiling over. A crash is unlikely as long as they uphold high standards.

Foreclosure Activity

Foreclosure activity — the number of forced home sales — is another important factor that says a lot about the housing market. Increased foreclosures mean more homeowners can’t afford their mortgage payments. Prices usually decrease in direct reaction.

Foreclosure activity represented .23% of all housing units in 2022, which is a sharp increase from 2021. However, it doesn’t compare to the 2.23% peak in 2010, so market conditions aren’t nearly as desperate as they were while America was recovering from the 2007-09 recession.

Real estate investors can expect foreclosure activity to sharply increase if an economic recession occurs. Most homeowners can afford their mortgages for now.

How Does a Market Crash Affect Homeowners?

a happy family with kids worried about what happens if the housing market crashes

Even with these factors in mind, estimating the possibility of a housing market crash is still difficult. There are good and bad signs. What would the chain reaction look like if a crash did occur? How would it affect homeowners?

The first thing to happen would be a sudden decrease in home prices. Many homeowners would then owe more money on their mortgages than the value of their properties. Selling the house or refinancing their loans would be extremely difficult, leaving them in financial purgatory. 

A market crash would also lead to a spike in foreclosures as homeowners who can no longer afford their mortgage payments are forced to give up their houses. High foreclosure activity makes local markets look bad, which lowers property values throughout the community. Location is the most important factor in determining a home’s value, so living near a handful of foreclosures can cause a huge problem.

The ripple effect doesn’t stop there. Banks will become much more cautious with their loans as housing prices plummet. They will raise mortgage interest rates so they only have to work with people in high income brackets who are guaranteed to pay off the loans. The average buyer gets left behind, which worsens the housing crisis.

With fewer people buying homes and starting families, job losses and consumer spending would also decrease. A housing market crash would almost certainly result in a widespread economic crash and vice versa. The only question is, which is more likely to come first? Consider the 2008 market crash to find noteworthy patterns.

What Happened to Homeowners When the Housing Market Crashed in 2008?

Housing market conditions in 2023 and 2008 share one or two similarities but differ in many ways. The most notable similarity is that both markets have fixed mortgage rates in the 6%-7% range, which is high but not disastrous. In previous recession periods like 1981, mortgage rates reached as high as 18%. In 2000, they were around 8%. 

When the market crashed in 2008, property values plummeted, foreclosures reached 2% and millions of families lost their homes. Homeowners who could keep their properties didn’t fare well, either. The value of their most important investment disappeared. The economy hit a wall as consumer spending decreased and unemployment increased. This outcome is a real possibility in the near future.

Even in 2023, many people still feel the painful effects of the late 2000s recession. However, the recent downturn pales in comparison to the Great Depression. It’s important to get perspective on this issue, so it helps to see how desperate the economy was in 1929 compared to the current situation.

1929 Wall Street Crash and Great Depression

dollar, 100 dollar bill, dollar burning

The stock market crash of 1929 is considered the worst economic event in world history. Due to an increasingly unstable economy, investors across the country collectively traded in almost 13 billion shares in a few weeks. There were many reasons for this sudden reaction, including low wages, debt accumulation and an excess number of non-liquidable bank loans.

The market had become overconfident after the Roaring ‘20s, as more people were buying stocks with easy credit. Nobody was afraid of accruing debt. Then, the Federal Reserve raised interest rates from 5% to 6% in August 1929. People started to trade in their stocks, prices spiked and chaos ensued.

Aside from the high interest rates and housing prices, the current situation is quite different from the pre-Great Depression economy. Buyer enthusiasm has not dwindled in response to high prices. People are still looking to buy homes and haven’t totally abandoned their stock market investments. It seems that investors have learned from the past.

However, the average homebuyer won’t be optimistic forever. A positive attitude also won’t be enough to overcome the housing market’s affordability issues. Interest rates need to restabilize to get the economy back on track.

How Are Interest Rates Determined?

An interest rate is the price people must pay to borrow money. The higher the interest rate, the more people are willing to request loans rather than spend their own money. Higher interest rates contribute to a higher return on investment.

A country’s central bank — the Federal Reserve, in the case of the United States — determines the interest rate. The Fed changes rates based on economic conditions, namely the law of supply and demand. When there is more demand than supply, like the current state of the housing market, the Fed has to increase the interest rate to keep the market from collapsing.

The same concept applies to lending money. The number of people who want to borrow and lend must remain balanced. Otherwise, interest rates will fluctuate and the economy will be unstable.

That’s why the Fed has increased interest rates for housing. There are too many borrowers for lenders to keep up with. Raising rates shrinks the borrower pool and restores balance to the market, at least in theory.

What Happens to Interest Rates if the Housing Market Crashes?

If the housing market crashed, homebuyers and investors could expect interest rates to rise even further. A crash would result in lower prices, which would rapidly increase the demand for loans. Higher demand would force the Fed to raise interest rates to keep things balanced.

On the other hand, a market crash could cause interest rates to drop. If people lose their patience and stop requesting loans, the Fed would have to decrease interest rates to get their attention. Home prices, credit availability and the overall economy would also see sudden and severe fluctuations during a crash.

The current situation is unprecedented in many ways. Unlike previous recessions, the country wasn’t recovering from a health crisis that brought the entire economy to a standstill. People can only speculate about what would happen to interest rates if the housing market crashed.

The Fed also controls 30-year fixed mortgage and direct interest rates on home equity lines of credit (HELOCs). Mortgage rates and HELOCs tend to increase in conjunction with higher interest rates.

Is It Wise to Buy a Home During a Market Crash? Why or Why Not?

Generally, buying a home during a market crash isn’t a good idea. It’s better to wait for prices to restabilize before making such a massive commitment. However, an individual’s unique financial situation is the most important factor. If they have the income to afford a new house during a crash, they could probably afford one in any market conditions.

Someone needing to relocate due to a job opportunity or family matters will have limited options during a market crash. That means they will face stiff competition from other buyers, who are also likely relocating by necessity. Negotiations could get ugly. If a market crash occurs, buyers should try to wait out the storm.

What to Expect From the Housing Market Regardless of a Crash

Investors can expect the housing market to have a slow and arduous recovery regardless of a crash. It will take at least a few years to solve issues like construction labor shortages, supply chain mismanagement and the high cost of living. The housing market can only regain stability after these external factors are addressed.

People would gain more buying power if prices decrease, but sky-high mortgage rates and cost of living might offset the price decrease and leave buyers and sellers in a pinch. More houses would be available, but both parties would be disappointed because too many outside factors are working against them.

Housing availability and affordability will remain problematic as long as the rest of the economy underperforms.

Home Prices Will Fall Through 2024

Although predictions for upcoming housing prices are all over the place, it’s safe to assume that prices will continue to drop. Some predict an 8% decrease, while other analysts are calling for a 20% drop through 2024, which is great news for low-income families. Such a drastic price change is known as a housing market correction.

Many Gen Z and millennial buyers got phased out of the market in 2021 and 2022, so if they can get back into the fold, the market’s activity will increase and help to accelerate its recovery. 

Is 2025 a Good Time to Buy a House?

Sellers have had all the leverage in homebuying negotiations in the last few years because buyers had so few options, but it looks like this trend is reversing. Prices are dropping and homes will slowly become more affordable. By the time 2025 comes around, the housing market could firmly be in the buyer’s favor.

In a buyer’s market, sellers must work extra hard to make their home listings stand out. They will make more renovations, take care of the landscaping and make other efforts to improve the community and property value by extension. Buyers will have more quality options. Competition is great for everyone, even those not interested in buying or selling.

Buyers Should Make the Largest Down Payment They Can Afford

People looking to buy a house shortly must make the largest down payment possible. It provides a lower loan-to-value ratio and increases their chances of getting a mortgage because they pose less risk to lenders. It also results in a lower interest rate on the house, which makes it more affordable in the long run. 

Plus, making a large down payment demonstrates someone’s commitment to homeownership. When sellers know buyers mean business, they take price negotiations more seriously.

Why Is Owning a House Better Than Renting?

Owning a house is better than renting for one simple reason: People have their own land, which is the most valuable asset money can buy. Homeowners also have the freedom to renovate the house to their liking, which isn’t an option for renters. Homeownership certainly comes with more responsibilities, but it also brings more freedom and financial security.

The Near Future Looks Clear

Although many aspects of the housing market’s current situation are unprecedented — recovering from a pandemic, labor shortages and supply chain disruptions — the near future is starting to show more clarity. Home prices dropped from their record highs in mid-2022, and the market shows signs of restabilization. 

Although a market crash and recession are certainly still on the table, it’s more likely that the market will experience a slow and deliberate revival as the economy recovers from the global health emergency.

FAQs

Q: Is a housing market crash good for buyers?

A: In the short term, a housing market crash isn’t good for anyone. However, the market will shift toward the buyer’s favor after prices drop and the Fed brings interest rates back to affordable levels.

Q: What goes up when the housing market crashes?

A: Although home prices would suddenly drop, mortgage rates and foreclosure activity would increase. So, the overall costs of financing a home would go up.

Q: What happens to house prices when the economy crashes?

A: Market activity slows down and prices drop during an economic recession. However, this doesn’t mean housing will suddenly become affordable. Inflation and the high cost of living would still prevent most prospective buyers from relocating.

Q: What are the consequences of a housing crash?

A: A severe drop in property values, spike in foreclosure rates, stricter lending standards, higher unemployment and lower consumer spending are among the most severe consequences of a housing market crash.

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