Buying a new home – how to spot a real estate bubble

ISS_4266_05775.jpg

When it comes to buying a new home, there are many factors that will influence when you buy, the type of property, and the location in which you choose to purchase. One factor which people don’t always consider when buying a new home, however, is whether there is a real estate bubble in place. A bubble is when property prices are artificially inflated for any of a number of reasons, and this carries the risk that when conditions change the value of properties can fall rapidly, potentially resulting in negative equity and, in extreme cases, foreclosures. Property bubbles can be national in nature – caused by broader economic conditions – but they can also be localized. Here are some of the warning signs that the real estate market may be entering a bubble or prone to a crash.

1.     Look out for shaky loans– Loose lending practices in the past have included interest-only loans and adjustable-rate mortgages which borrowers may not be able to afford if interest rates go up. These and other forms of so-called subprime lending were prime factors behind the 2008 housing crash and subsequent global financial crisis. While lenders have almost universally tightened up lending practices in the years since, it still pays to keep an eye on a rise in more “creative” lending products and practices as a sign of a pending bubble.

2.     Decreasing down payments– Simply put, the more money you put down as a percentage of the purchase price when buying a new home, the smaller the risk to the mortgage lender in the event that either housing values crash or the borrower can’t keep up with the repayments. Conversely, smaller deposits equal higher risk. If the real estate market shifts to homebuyers putting down smaller down payments, it could be a sign of an approaching bubble.

3.     Cost of living outstripping salaries – Real estate bubbles can occur when living expenses start rising faster than salaries. Where runaway price inflation outstrips wage growth, there is the potential for a real estate bubble and subsequent crash. This can be particularly evident in fast-growing cities.

4.     Flipping and real estate investment– At times and in locations where a lot of people are buying property to renovate and flip, or are purchasing a new home for saleto lease out rather than live in, that can have a big effect on driving up house prices and creating a real estate bubble. Once again, widespread house flipping and investment purchases were the norm in the years leading up to the 2008 property crash.

5.     Rising interest rates – Lower interest rates make mortgages more affordable for would-be homebuyers, and help keep real estate market demand high. Rising interest rates, on the other hand, cause housing demand to fall, sinking the housing market and potentially signaling the end of a property market boom.

While most experts agree that we aren’t currently in too much danger of a national property bubble – interest rates are still relatively low and tighter lending practices in the past few years have acted as a brake to higher-risk lending – it’s still worth keeping an eye out for the factors outlined above before making a decision to buy a new home for sale.