We're Not in a Housing Bubble -- but We Could Be If This Happened

To say that today's housing market is a tough one to crack would be an understatement. Not only are home prices soaring, but borrowing rates have risen sharply since the start of the year, making it even harder for buyers to afford property.

Based on the way things are going, some people may be worried that we're headed into a housing bubble that's about to burst. But right now, homeowners and real estate investors with income properties in their portfolios can rest easy, because that's not where we are. Things could change, though, if one key thing happens.

A house with a for sale sign in front of it.

Image source: Getty Images.

It all boils down to inventory

When the last housing bubble burst, the real estate market looked very different -- namely, it was oversaturated with homes, and there wasn't enough demand to keep up with them. Not only that, but due to poor lending practices, homeowners were defaulting on their mortgages in droves, creating an excess of inventory at a time when general economic conditions were worsening and buyer demand wasn't particularly strong.

Fast-forward to today: The economy is faring well right now, but many experts are already sounding recession warnings. And there's reason to believe they're right.

In an attempt to slow inflation, the Federal Reserve is raising interest rates, which will, in turn, make borrowing more expensive. Once that happens, consumer spending could shrink, leading to a recession. And as economic conditions deteriorate, the fear is that buyers will be less inclined to purchase homes.

But even if the economy does take a turn for the worse, we're unlikely to see a glaring mismatch between supply and demand in the housing market for one big reason: a lack of inventory. As of April, there was a mere 2.2-month supply of available homes for sale, per the National Association of Realtors. That's well below the typical four- to six-month supply needed to create an equalized housing market.

If housing inventory picks up in a meaningful way, home prices could begin to plummet. But there are no indications that that's about to happen.

Not only are sellers still hesitant to list their homes, but supply chain shortages and higher costs are putting a damper on plans to build new homes. And until that situation resolves, housing inventory is likely to remain sluggish enough that it can absorb a decrease in buyer demand.

There's no need to stress just yet

Home prices could decline at some point in time. But are we likely to see a massive drop in home values anytime soon? Probably not.

Let's also remember that during the last housing bubble, many homeowners got in over their heads by taking on mortgages they couldn't afford. These days, homeowners are sitting on record levels of equity. Therefore, even if economic conditions worsen and job loss becomes rampant, homeowners will have more options for staying in their homes, thereby lending to an ongoing lack of inventory.

Furthermore, the last housing bubble was, as mentioned, fueled by irresponsible lending practices and droves of buyers taking on mortgages they couldn't afford. But lenders have since increased their credit standards and made it harder to borrow, so now only qualified candidates are able to do so. That alone makes today's housing market notably different from the conditions that led to the last housing bubble and its eventual burst.

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