United States housing bubble

The United States housing bubble is the economic bubble in many parts of the U.S. housing market from 2001 to 2005, especially in populous areas such as California, Florida, New York, the BosWash megalopolis, and the southwest markets. A real estate bubble is a type of economic bubble that occurs periodically in local or global real estate markets. The housing bubble in these and other parts of the U.S. was caused by historically low interest rates, poor lending standards, and a mania for purchasing houses. This bubble is related to the stock market or dot-com bubble of the 1990s.

A housing bubble is characterized by rapid increases in the valuations of real property such as housing until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This in turn is followed by decreases in home prices that can result in many owners holding negative equity, a mortgage debt higher than the value of the property.

Bubbles may be definitively identified only in hindsight, after a market correction. The impact of booming home valuations on the U.S. economy since the 2001–2002 recession was an important factor in the recovery because a large component of consumer spending came from the related refinancing boom, which simultaneously allowed people to reduce their monthly mortgage payments with lower interest rates and withdraw equity from their homes as values increased.

Low interest rates and lax lending standards

The recent use of subprime mortgages, adjustable rate mortgages, interest-only mortgages, and “stated income” loans (also known as “liar loans”—a subset of “Alt-A” loans) to finance home purchases described above have raised concerns about the quality of these loans should interest rates rise again or the borrower is unable to pay the mortgage. In March 2007, the United States’ subprime mortgage industry collapsed due to higher-than-expected home foreclosure rates, with more than 25 subprime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale. Harper’s Magazine warned of the danger of rising interest rates for recent homebuyers holding such mortgages, as well as the U.S. economy as a whole: “The problem [is] that prices are falling even as the buyers’ total mortgage remains the same or even increases. … Rising debt-service payments will further divert income from new consumer spending. Taken together, these factors will further shrink the “real” economy, drive down those already declining real wages, and push our debt-ridden economy into Japan-style stagnation or worse.”Factors that could contribute to rising rates are the U.S. national debt, inflationary pressure caused by such factors as increased fuel and housing costs, and changes in foreign investments in the U.S. economy. The Fed raised rates 17 times, increasing them from 1% to 5.25%, between 2004 and 2006. BusinessWeek magazine called the option ARM “the riskiest and most complicated home loan product ever created” and warned that over one million borrowers took out $466 billion in option ARMs in 2004 through the second quarter of 2006, citing concerns that these financial products could hurt individual borrowers the most and “worsen the [housing] bust.” To address the problems arising from “liar loans”, the Internal Revenue Service updated an income verification tool used by lenders to make confirmation of borrower’s claimed income to be faster and easier. In April 2007, financial problems similar to the subprime mortgages began to appear with Alt-A loans made to homeowners who were thought to be less risky; the delinquency rate for Alt-A mortgages has been rising in 2007. The manager of the world’s largest bond fund PIMCO, warned in June 2007 that the subprime mortgage crisis was not an isolated event and will eventually take a toll on the economy and whose ultimate impact will be on the impaired prices of homes.

Approximate cost to own mortgaged property vs. renting

An approximate formula for the monthly cost of owning a home is obtained by computing the monthly mortgage, property tax, and maintenance costs, accounting for the U.S. tax deduction available for mortgage interest payments and property taxes. This formula does not include the cost of foregoing the standard deduction (required for taking the tax deduction). Assuming a home cost of P dollars, yearly interest rate r fixed over N years, marginal income tax rate rIT, property tax rate rPT (assumed to be ½–2% of P), and yearly maintenance cost rate rM (assumed to be ½–1% of P), the monthly cost of home ownership is approximately