Popping Bubbles: How the Housing Market Works
Finance/Money

Popping Bubbles: How the Housing Market Works

The housing market is a complex and intricate system made up of thousands of moving parts. A market can be easily defined as the sum of all of the transactions of everybody buying and selling a certain good or service. To fully understand the housing market, you need to understand the financial processes surrounding the transactions in the market.

There are, of course, buyers and sellers of all types. Buyers can range from private individuals to organizations, such as Home Buyers USA, that buy real estate in massive quantities. These individuals put up either the entire price or more commonly, a small portion of the price in cash and the rest in credit that is paid off over time, plus interest. Sellers are similar; there are individuals selling their properties as well as massive organizations that deal in real estate.

Since buying real estate is highly dependent on the number of credit people can borrow, the overall interest rate on mortgages has a strong factor in how individuals buy. Let me explain the entire process based on the fact that most people have to borrow at least some amount of money to purchase a house.

The buyer first decides that they want to purchase a property. After searching and finding one that suits their needs, they then make an offer to purchase. Should the offer be accepted, typically, a down payment is the only large sum paid at a single time, while the rest of the money is put up by a bank to be paid off slowly. This repayment of money to the bank is the mortgage.

The bank doesn’t offer this service for free, however. On top of the monthly payments that go towards paying down the loan, there is an interest rate applied to the amount of money that still has to be paid off. This interest rate is their fee for lending a buyer the money to purchase the property. Once the mortgage has been paid off, the buyer will typically have spent several thousand dollars extra in interest payments.

When interest rates are low, more people are willing to take out a mortgage. This is because of their ability to repay them over time since the overall cost of buying a house will be lower due to less interest. This, in turn, causes many people to go out and buy houses because of their increased purchasing power. Because of the increased amount of buyers, sellers are able to raise their prices for houses. Now, a bubble is forming.

When this rush of people decides to borrow money from the bank, the bank now has a higher number of liabilities should the people they lent money to aren’t able to repay them, so they need to disincentivize taking out a loan. To do this, they raise interest rates. Now, people are less likely to take out a mortgage because the interest payments will make the final price to buy a house much too high. People who have their existing mortgages renewed under the new interest rate will also have to adjust their budget to make up for the increased cost of repaying their debts.

This makes for a sharp decrease in overall spending since many people now have a large burden of debt to repay from their income that could be spent on other things. Since someone else’s spending is someone else’s income, there’s less money going around overall and fewer purchases are being made. This is the bubble popping since fewer people are buying houses in general. House sellers begin lowering their prices so they can pay off their debts, and because there are fewer customers willing to pay the higher prices.

This cycle tends to repeat itself once every decade or so, give or take a few years each way. If you understand the trends in the housing market, you’ll be able to make much more informed decisions as to whether or not it is the right time to buy or sell.

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