Housing market crash: What caused it in the past, and will it happen again?

What homeowners and homebuyers should know

Rising inflation, a white-hot housing market and a potential economic recession — it seems like everyone from politicians to the mail carrier have been talking about these issues lately. And although these topics can cause stress, being informed about past economic crises can help you ease some of your worry and avoid making fear-based financial decisions.

Read on to learn what caused the housing market crash in 2008, what some experts are saying about the housing market this time around and how you can prepare yourself financially for whatever the future holds.

Is the housing market going to crash?

The short answer: No one knows for sure.

Although it has begun to cool down a bit recently, the housing market has been hot for the past couple of years.¹ High demand for homes and a severely low supply have led to inflated prices and bidding wars across the country. These conditions, combined with other economic and global factors such as rising interest rates and the economic fallout of the war in Ukraine, have many people concerned that the current housing market is a bubble that will burst, causing a real estate crash similar to the one in 2008.

But the onset of another recession could simply lead to an economic slowdown without causing a housing crash like the one we saw 14 years ago. Ultimately, the real estate market is cyclical with many highs and lows over past decades.

What caused the 2008 housing market crash?

In 2008, low interest rates and lax lending standards enabled millions of Americans to purchase homes they couldn’t afford. The high demand for housing in the years leading up to the crash was partly caused by predatory lending practices: Lenders were motivated to sell subprime mortgages to people who likely wouldn’t have qualified for conventional mortgages.

Home buyers with subprime mortgages saw their payments rise as much as 60% by 2006, making payments difficult to meet. When their homes eventually went into foreclosure, the housing market crashed. At that point, banks and other investors were left with trillions of dollars of bad investments on subprime mortgages, while millions of Americans lost their homes.

A look at the 2022 housing market

So how does today’s housing market compare to the market leading up to 2008? It’s actually pretty different. In 2008, the supply of homes for sale was soaring. In 2022, it’s historically low.²

What’s more, people taking out mortgages today are for the most part much more creditworthy than those who took out subprime mortgages in the 2000s. These signs indicate that we may not be in for a repeat of 2008 — but it’s still important to be prepared in case the housing market takes a big hit.

What home buyers and owners can do

You can’t control whether another housing market crash occurs, and much of what will happen in an economic downturn remains to be seen. However, you can take steps to protect yourself against a potential crash and ensure you’re in good financial shape no matter what the future holds.

Here are some things to do to set yourself up for financial security:

• Build an emergency fund that will cover at least six months of expenses in case you lose your job or face another unexpected financial emergency.
• Prioritize paying off your debts — especially those that have adjustable or variable interest rates, which rise during periods of inflation. Paying down debt can put you in a more comfortable financial position in case of a recession and housing market crash.

Advice for potential home buyers

If you’re considering buying a home, it can be a challenge when the supply is low and the demand is high. Keep these things in mind as you explore the housing market:

• Avoid making an emotional or impulsive decision. Take your time, and never buy a more expensive home than you can afford. Many experts recommend that you aim to spend no more than 28% of your gross monthly income on home-related costs.
• Avoid zero down payment plans. Purchasing a home without a down payment can seem appealing in the short term, but you’ll likely be stuck with a higher interest rate than you otherwise would, and you’re at a greater risk of owing more money than your home is worth over the long term. Instead, opt for at least a 20% down payment.
• Don’t buy a home for the short term. A good rule of thumb is to only purchase a home if you plan to live there for at least five years. Otherwise, now may be the time to rent. While homeowning can be a great long-term wealth generator, most houses come with high initial costs.

Advice for homeowners

If you already own your home, there are a few steps you can take to protect against a potential housing market crash.

• Avoid taking out a loan against your home. Focus on building an emergency fund in case you suddenly need cash, rather than relying on a home equity loan or line of credit.
• Look into refinancing your existing mortgage, if you have one. Lowering your rate by just 0.75 percentage points can save you a couple of hundred dollars a month or more.
• Think twice about putting your house on the market. It can be tempting to sell your home when you see how much money you could make on it. But where will you live once you sell? Will you then have to buy a home in a highly competitive market? Be sure to consider all the pros and cons before putting up a “for sale” sign.

Will the housing market crash? Maybe — or maybe not. But if you’re a homeowner or looking to become one, it’s best to be prepared for whatever may come next.

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