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Housing prices across the nation are slipping, making some savvy investors seem not so savvy and some fortunate families a lot less fortunate. What has caused this period of bliss followed by the current downturn in the housing market? When will the downturn end?

Setting the Stage for a Boom

Remember in the 1990’s and 2000 when dot-com stocks were all the rage? People would get money from investors without having a real business plan. This mostly happened because the Internet was still young and no one really seemed to apply real business sense to the businesses being opened ‘virtually’ online. As an example, one company dedicated itself to selling dog food online that would be delivered to your door. The costs of delivering dog food in the mail is high, given the weight of the bags, and consumers usually just buy it with their groceries anyhow.

Anyway, as time went on the ‘dot-com bubble’ burst, sending the stock market into a downward spiral on March 13,2000. The NASDAQ stock exchange fell 9% from March 10-15, 2000. This being the case, many companies and individuals who had experienced large returns on their investments now found themselves needing to find other ways to fund projects, many of which were already underway. Many initiatives were canceled, others put on hold, the economy was beginning to slow.

In response the FED, who controls the interest rate at which banks can borrow money from the government, began to lower the interest rate. Banks lend money to businesses and people. This rate began to fall until Decemeber 2003 when the rate fell below 1%. This decrease was done to spur the economy, create jobs, etc. The interest rate decrease helped significantly in this effort.

The Housing Market

With the lower rates being offered by the federal government, banks and mortgage companies began to offer lower rate mortgages, making monthly payments drop. A decrease in price leads to an increase in demand. People with small homes wanted to get into medium sized homes, owners of medium sized homes wanted to get into a larger home, house flipping became popular, and some consumers even began looking for second homes.

Since 1975 the fluctuation in home prices has closely mirrored the income of families and inflation rates. Because there is a lag between the time an increase in demand in housing occurs and the ability to produce more housing, the overall price of homes increased. This increase in home prices led many home owners to cash in and upgrade. Many builders began to find it more profitable to create new housing. Supply began to meet the demand.

Keeping up with the Joneses

The housing boom lead many consumers to believe that conditions would continue the way they were, low interest rates, etc. If your mindset is that housing sells fast and interest rates are low and you don’t think that will change, you are more inclined to bite into Adjustable Rate Mortgages (ARM).

Many investors planned on investing in a house for a couple of weeks and ‘flipping’ it. ARM mortgages make sense if this plan works. Demand increased again, even though prices were higher because lenders everywhere discovered how easy it was to get consumers into larger homes than they could afford. At the height of the housing boom ARM loans accounted for about 20% of the total mortgage debt in the country.

In addition to ARM loans, brokers began offering what have since become known as ‘liar loans.’ Brokers would take you on your word as to how much income you had. Less and less documentation was required. The problem now being brought to light about ARMs and Liar loans is that many times the consumer didn’t quite understand what they were getting into.

What goes up must come down

It seems that the ‘keeping up with the Jonses’ and the lair loans teamed up to create a false sense of need for more housing. Investors continued to search for houses to flip, builders continued to build at an alarming rate. Because it is easier to make a profit when money is borrowed, the whole market was over extended on credit.

The Fed, to decrease the likelihood of high inflation, began to increase interest rates. Individuals with ARMs began to see their monthly payments increase, house flippers could no longer sell their homes, and builders saw homes stay vacant for months.

In spring of 2007 many consider the housing bubble to have burst. With fewer buyers buying, investors and home owners alike began to feel the pinch. Many with ARM loans began paying higher rates because the introductory teaser rate had expired and found that they could no longer make ends meet.

Soon consumers with ARM loans and liar loans had there propertied foreclosed on simply because there were no buyers looking for new homes. In addition to higher monthly payments, home owners everywhere began to be subject to higher property taxes. Property tax is based on the market value of the home, and with prices increasing, so did the taxes.

Visit almost any neighborhood today and you’ll see several houses for sale. Visit the same neighborhood in a few months and you will see more houses for sale, with the first ones’ signs still posted in their yard. Experts say that we aren’t out of the mess yet, but hopefully we’ve learned our lesson.

Today’s Market, Tomorrow’s Prices: Part 2 coming soon!

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