What Happens to Homeowners If the Housing Market Crashes?

Whether you’re a homeowner, renter, or living with family, the health of the real estate market will impact you. It’s important to know what happens to homeowners if the housing market crashes so that you can hedge your finances.

A housing market crash doesn’t happen suddenly. It’s the culmination of several economic variables that result in a housing bubble followed by a sudden and sharp decline in property values, potentially leading to significant losses for homeowners and investors.

For a major crash to happen to the US housing market, we usually expect to see amplifying factors, such as an economic recession, a sudden increase in interest rates, or an oversupply of homes on the market.

However, what directly creates the crash is an imbalance in the supply and demand cycle. That means that there are more homes for sale than buyers. As a result, home prices drop, and homeowners can find themselves in a financial position where they are “underwater” on their property.

In this article, we will discuss the current US economic climate and its impact on the housing market. Discover how a combination of lending policy and new housing supply is ensuring we have a resilient housing market. Learn the real-world consequences of a housing market crash and what happens to homeowners.

Is the Housing Market Going to Crash?

Historically, one of the first indicators of a housing market crash is high mortgage rates. During the COVID-19 pandemic, most major economies across the world saw interest rates plummet to near zero in an effort to support handicapped economies. Loans were easier to obtain, and the low cost of debt inevitably drove up housing prices. However, extremely low interest rates are unsustainable and resulted in skyrocketing inflation.

Most people don’t fully understand that sustained high inflation rates can destroy an economy. The US inflation rate had to be brought under control, and the Federal Reserve was forced to increase interest rates rapidly. Interest rates in the United States began to increase notably in March 2022.

By the end of 2022, the Fed had raised interest rates seven times, bringing the rate to a range of 4.25% to 4.50%. The increases continued into 2023, with the rate peaking at a range of 5.25% to 5.50% by July 2023, where it still sits over a year later (August 2024). This was the highest level in 22 years, reflecting the Fed’s ongoing efforts to stabilize inflation while managing economic growth.

The Federal Reserve’s interest rate directly impacts home mortgage rates, which is why we have seen mortgage interest rates ranging from 6-8%. So, with the understanding that high interest rates usually indicate a housing market crash, you probably think we must be headed for a crash.

Not necessarily. In fact, most economists strongly agree that the US housing market will not crash anytime soon, and they are probably right. While high interest rates typically cause home prices to correct, three additional factors are holding up home prices: revised lending standards, limited new home supply, and home equity levels.

Lending Standards Post-Great Recession

The Great Recession (also known as the Global Financial Crisis) of 2007 was a financial crisis that left most Americans scarred. Home prices plummeted, resulting in record-breaking levels of foreclosures and short sales.

However, the driving factors in this economic downturn were loose lending standards and adjustable rate mortgages (ARMs). That means homebuyers were offered mortgages they couldn’t necessarily afford and with interest rates that could increase with economic changes.

ARMs often start with a low introductory interest rate, known as a teaser rate, which lasts for a set period (e.g., five years). This low rate makes ARMs initially more affordable. Once the initial period ends, the interest rate on an ARM adjusts periodically based on a specific index plus a margin.

These adjustments can cause significant increases in the mortgage rate and, consequently, the monthly payment. Borrowers who stretched their finances to afford their homes during the teaser period then find themselves unable to meet the higher payments, a phenomenon known as payment shock.

As more borrowers experience payment shock, the likelihood of defaults and foreclosures rises, resulting in an increase in housing supply during an economic environment with expensive debt and reduced demand.

2024 is not 2007. After the 2007 financial crisis, major changes were made to mortgage underwriting, such as:

• Increased scrutiny of buyers borrowing capacity.
• Higher credit score requirements
• Income verification requirements
• Higher down payment requirements

Possibly more significant today is the significant reduction and tightening of subprime loan products like ARMs. We have different lending regulations, and most homeowners have fixed-rate mortgages, meaning they didn’t qualify based on a promotional discounted interest rate. Their interest rates won’t change based on market conditions. Therefore, many homeowners are not facing higher monthly payments due to increased interest rates.

Lending standards are having a massive impact on the housing current housing market, effectively resulting in the complete opposite outcome to 2007. Homeowners who actively enjoy lower mortgage rates are choosing not to sell or move during the current high interest rate climate, limiting housing supply.

Housing Supply

There are two main types of housing supply: new construction and the secondary market. The secondary market consists of homes that have previously been owned by consumers and are being resold. New construction homes are being sold to homebuyers for the first time and are adding supply to the overall number of housing units.

As mentioned, many homeowners are choosing not to sell their properties because re-buying would mean locking into a much higher interest rate. High interest rates have frozen the housing market across most regions.

When it comes to new construction, the short answer is that we don’t have enough of it. At the time of the 2007 crash, new construction development had gone rampant, and plenty of new homes were in the development pipeline.

Many major home development companies went out of business, and today, real estate developers remain hesitant to overdevelop while household numbers continue increasing. As a result, the US housing market as a whole is in a severe supply deficit, meaning that there is more demand than supply.

A recent Zillow article states that the US currently has a deficit of 4.5 million homes. While new construction is happening, not enough homes are being built to fulfill growing demand, and the deficit is increasing yearly.

Home Equity Levels

Home equity levels play a significant role in the dynamics of a housing crisis. When homeowners have a substantial amount of equity in their homes (i.e., the home is worth significantly more than the remaining mortgage balance), they have a financial cushion and incentive to continue making their mortgage payments.

If they can no longer make their payments, these homeowners are less likely to default on their loans because they can sell their homes and still pay off their mortgages.

When home equity levels are low or negative (when homeowners owe more on their mortgage than the home is worth, also known as being “underwater”), homeowners are more vulnerable in a downturn. Some start questioning why they are making mortgage payments on a loan that is higher than their home’s value.

Others might fall into a position where they can no longer make payments. As a result, distressed sales, foreclosure, and short sale numbers increase, increasing the housing supply and lowering housing prices. We saw this when the housing market crashed in 2007.

Currently, home equity levels are near record highs, so negative equity poses a very low risk to the housing market.

The Housing Market Isn’t Crashing in 2024

Interest rates might influence the real estate market and housing prices, but they’re not the only factor that leads to a housing market crash. Currently, the US real estate market remains robust and resilient to rising interest rates and even rising unemployment rates. There is no housing market crash in sight.

Homeowners and potential buyers can expect some continued volatility in the real estate market. They can also expect to see some corrections in housing prices, especially in the more expensive real estate markets.

What Happens During a Housing Market Crash?

The risk of a housing market crash is never zero; it can happen and impact homeowners and home buyers. In our current economy, to effect a housing market crash, we’d have to face another major economic crisis, such as:

• A severe job market crash.
• Widespread income decline with reduced consumer and investor confidence.
• The collapse of a major financial institution (or several smaller ones).
• Policy and regulatory failures.
• Major geopolitical events, such as a war or trade conflict that disrupt the global economy.

When the housing market crashes, it’s a cyclical process that usually requires regulators to step in with policy changes.

Tightening of Credit

During any economic downturn, lenders tighten credit, and interest rates increase. Currently, interest rates are already high in response to high inflation.

However, when a housing market starts to crash, banks and lenders tighten their credit standards to accommodate for increased risk, making it more difficult for prospective buyers to obtain mortgages. This makes it harder for homeowners to tap into their home equity for loans, as falling property values reduce the amount of equity available.

Sharp Decline in Home Prices

The most immediate and noticeable effect of a housing market crash is a rapid decline in home prices. The core trigger for the decline is an oversupply of homes relative to demand. However, it’s driven by other economic factors that lead to an overall economic downturn.

As home values and equity fall, homeowners may find themselves making mortgage payments on loan amounts that are higher than their property values. When homeowners are “underwater” for an extended period of time and face subsequential financial hardship, they often choose to short sale.

When many owners face financial hardship at the same time and are forced to sell their homes, it leads to an increase in housing supply. If there are not enough buyers in the market (which can happen if interest rates are high), the housing market becomes oversaturated, leading to further housing price decline.

Increase in Foreclosures

Homeowners who are unable to keep up with mortgage payments, often due to job loss, payment shock from adjustable-rate mortgages, or negative equity, may face foreclosure. This leads to a surge in foreclosed properties, further flooding the market and driving prices down even more.

When banks take possession of homes, they don’t want to hold them longer than necessary. These properties get sold at discounted prices with a negative perception from buyers, further decreasing market prices.

What Happens After a Housing Market Crash?

A housing market crash doesn’t end with the initial fall of home prices. The impacts of a crash can have a lasting impact on the housing market.

The recovery from a housing market crash can be slow and uneven, with some regions or market segments taking years to return to pre-crash levels. Homeowners who bought at the peak of the housing market may face long-term financial strain if they need to sell at a loss. A crash can lead to long-term changes in the housing market, including shifts in buyer behavior.

Decrease in Home Value

A sharp decline in home values is one of the most immediate consequences of a housing market crash. For homeowners, this means that the equity they’ve built up over time can quickly erode. This decline can leave homeowners in a precarious financial position, particularly those who bought at the peak of the market.

Some may find themselves underwater on their mortgage. Homeowners with underwater mortgages may find themselves stuck, unable to sell their homes without taking a substantial loss to their overall financial position.

Home prices can remain depressed for an extended period, and it often takes years for homeowners to rebuild the equity in their properties.

Difficulty Selling

After a housing market crash, buyer demand can remain subdued while there is a surplus of homes on the market. As a result, we see a widespread buyer’s market. Homeowners who wish to sell may find that it takes longer for them to sell as buyers have more options.

Furthermore, sellers often need to provide seller concessions and accommodate buyer contingencies they wouldn’t overwise in a stabilized or seller’s market.

Impact on Refinancing

Refinancing offers homeowners several key benefits, primarily by enabling them to secure a better interest rate, which can lead to lower monthly payments. It also allows homeowners to access the equity in their home for significant expenses, remove private mortgage insurance (PMI) if they’ve built up enough equity, and consolidate high-interest debt into a single, more manageable payment.

After a market crash, refinancing becomes more challenging. While home values are decreased, lenders also make it more difficult to get financing. Homeowners may not have enough equity or income to qualify for refinancing.

Even if they do, the terms may not be as favorable as they once were, making it harder to reduce monthly payments or shorten the loan term. These conditions can lead to homeowners getting stuck in their mortgages, potentially leaving them with only one option: downsizing.

Changes in Property Taxes

As home values decline, so do property tax assessments. While this might seem like a silver lining, the reality is more complex. Lower property values can lead to reduced property taxes, which may provide some financial relief for homeowners.

However, local governments’ budgets don’t necessarily decrease due to economic downturns. on the contrary, they often have higher expenses. Local governments may increase tax rates to compensate for the reduced tax base, offsetting any potential savings.

Opportunities for Buyers

While a housing market crash is challenging for homeowners, it can present opportunities for buyers and investors. As home prices fall, those with the means to purchase can acquire properties at a discount.

This is particularly appealing for investors looking to expand their portfolios or first-time buyers previously priced out of the market. However, potential buyers should proceed cautiously, as the market’s volatility can make it difficult to predict future property values.

Overall Economic Challenges

A housing market crash can lead to a broader economic recession. The construction and real estate sectors, which are major employers, may see significant job losses. Reduced consumer spending, driven by declining household wealth, can further slow economic growth.

If the crash is severe, it can destabilize financial institutions that hold large amounts of mortgage-backed securities or are heavily involved in mortgage lending, potentially leading to a banking crisis.

As home values plummet, homeowners often feel less wealthy, leading to a decrease in consumer spending. This decline in spending can exacerbate the economic downturn, as consumption is a major component of economic activity.

How to Prepare for a Housing Market Crash

While we don’t appear to be headed for a housing market crash, preparing for a potential crash can help safeguard your financial stability and give you peace of mind.

By taking proactive steps now, you can mitigate the impact of a downturn and ensure you’re better equipped to handle any challenges.

Some strategies that will help you secure your financial security and weather a housing market crash are:

• Build an Emergency Fund: Save three to six months’ worth of living expenses to provide a financial cushion. Your savings can help you cover expenses in the case of job loss or injury.
• Consider Refinancing Options Early: Explore refinancing to secure a lower interest rate or switch to a fixed-rate mortgage, stabilizing your monthly payments on a fixed-rate loan.
• Reduce Unnecessary Expenses: Cut back on discretionary spending and pay down high-interest debt to free up cash flow and reduce financial stress.

By implementing these strategies, you can strengthen your financial position and be better prepared to endure the effects of a housing market crash.

Get to Know Your Local Real Estate Market

A real estate market crash is usually defined when there are country-wide (or worldwide) economic circumstances that impact the entire housing market. However, local housing markets react differently and can experience their own crash.

For example, cities like Miami, Denver, and Seattle are currently seeing considerable price decline in response to high interest rates. The most likely explanation is that they became overinflated during the recent market boom. However, more affordable cities like Toledo and Pittsburg are experiencing double-digit growth.

Housing market crashes can happen on a micro-level, so it’s crucial that homeowners stay on top of what is happening within their local market. The best way to get informed about your real estate market is with the help of a local real estate agent.

Real estate agents have up-to-date data and are being fed qualitative feedback from buyers and sellers on a daily basis. You don’t need to be selling or buying to form a relationship with a local real estate agent.

Connect with a top local real estate agent in your area. FastExpert’s database of real estate professionals can be searched by location and provides the feedback you need to find the best agent for your needs. Start your real estate agent search with FastExpert.