What happens when house prices rise through the roof?
They collapse!
Because, unfortunately, that's how it works.
Last year house price increased by double digits.
If you compare that to other assets such as stocks, that might not seem high; however,
a double-digit rise in real estate is a sign of a bubble.
The housing market didn't emerge yesterday like cryptocurrencies.
It's a well-established market that grows by around 2 percent annually to catch up with
inflation.
However, when prices started rising slightly faster as they did in 2008, the market crashed.
With such low interest rates, it was not easy to sit aside and not take a mortgage, or at
least refinance your house because even a one percent difference in your mortgage rate
is going to make a huge difference in the long run.
Let's say rates do rise a full 1 percent by the end of the year.
How much does a 1% difference in a mortgage rate make?
If your loan is 200K dollars, a 1% difference means you will pay an additional $35,935 over
30 years.
That's a lot of money if you ask me, and we didn't even take into account the opportunity
cost of that money, which means how much that money would have grown if you have invested
it.
A 1 percent difference on a 200K dollar loan equals an additional $239, which equals 518K
dollars if you invest it in the s&p500 for 30 years, assuming you will get a 10 percent
rate of return in the long run.
Imagine if you negotiate and get a slightly lower rate.
You will end up with an extra half a million dollars when you retire.
I think that's something worth considering.
What if your mortgage is 300K or 400K dollars?
That number would be significantly higher.
If you borrow $400,000, you will pay an additional $71,870 in interest over 30 years or $477
every month.
If you count the opportunity cost, it would equal $1,035,720.
that's why whenever you take a mortgage, the number one thing you should pay attention
to is your mortgage rate.
So when the fed lowered interest rates to almost 0 percent.
Everyone who had the opportunity to get a mortgage did actually take a mortgage which
led real estate prices to rise significantly in the middle of a pandemic.
Real estate prices didn't just rise, but they rose faster than income, which means fewer
people can afford a house now, but because mortgage rates were so low, it still made
economic sense to buy a house.
But what happens when mortgage rates will rise?
Which eventually will happen, the demand will significantly slow down, which could cause
real estate prices to crash.
Another factor that we have to consider is rent prices.
Usually, rent prices go hand in hand with house prices, sometimes one grows faster than
the other but not by a huge difference like it happened last year.
Which led man experts to believe that we might be repeating the same path as we did in 2008.
If the fed didn't intervene last year, then we definitely would have had a real estate
collapse since most people wouldn't be able to pay off their mortgages.
Most people live paycheque to paycheque, and the only reason they qualified for that mortgage
is because they had a constant stream of income.
But when millions of people suddenly can't make their monthly payments, the bank will
freak out and start selling these homes to make up the payments, but that means there
will be an oversupply of houses in the market which will drive the price down, which will
crash the market.
The U.S. has already experienced that.
Therefore the government said - listen, guys, you can take one year break from your mortgage
payments even if you can afford it.
That was the main reason why the market didn't collapse, but what happens when the forbearance
period is over, and the economy hasn't entire recovered yet.
When people have to make their mortgage payments, but they don't have the financial ability
to do that.
The pyramid will finally collapse!
Especially since prices were rising faster than ever, and that creates the expectation
of future rise.
That expectation attracts speculators who invest in the market, hoping to profit from
the rising prices.
This further increases demand and prices, causing the bubble to stretch and grow.
And on one beautiful day, it's going to burst.
In 2008, mortgages were not regulated much, so banks started giving loans randomly.
I am not saying that sarcastically, but that's literally what happened.
Mortgage underwriting got so sloppy during the housing bubble that some lenders were
giving out "ninja" loans—no income verification, no job verification, nothing.
On the other side, developers were building houses faster than the U.S. population could
occupy them.
It took a while, but eventually, prices plunged, people defaulted on their mortgages, and the
U.S. economy crashed, helping bring down the global economy with it.
When values crashed, some of these homeowners were unable to keep making payments.
And they couldn't sell the home for the amount they owed.
Banks didn't care much since they would take these mortgages, bundle them together and
sell them to investors in the form of securities.
That's why these banks kept calling people to convince them to take a mortgage and didn't
even require them to provide any documentation.
It made sense because everyone thought that home prices will always rise, isn't that what
your parents told you!
However, the unexpected happened!
If you give it a closer look, the housing market today is nothing like in the 2000s.
No one is getting a mortgage unless they can prove that they can pay it off.
Secondly, The homeowner vacancy rate is 0.9%, the lowest in the U.S. since 1956.
In other words, there's a shortage of houses this time, not an excess.
And when there is a shortage of supply in the market, the price naturally rise.
Since the 2008 crash, home builders were very careful because the banks have been heavily
regulated since then so there was no point to keep building new houses unless there is
a clear demand for them.
No one expected that suddenly there is going to be a pandemic, and the fed will lower interest
rates to 0 and mortgage rates would plummet to the bare minimum.
Remember at the beginning of the video where we talked about how big of a difference does
a single percentage makes in the long run?
That's why so many people jumped to buy a house.
So even though home prices rose significantly, smaller mortgage payments still attract buyers.
However, we also have to consider that 1 in 10 homeowners with a mortgage is behind on
payments, according to the U.S. Department of Agriculture, which could lead them to default
on their loan.
Of course, the forbearance program is going to be extended, but even if it's not, most
homeowners have accumulated substantial equity in their homes, so they could sell them and
pay off their mortgages in full with no sweat, which wasn't the case in 2008 when the fall
in prices caught people off-guard with big mortgages and little or no equity.
What's going to happen to the real estate market is entirely based on how well the fed
is going to manage it.
If the fed carefully lowers interest rates, there might not be any crash except that prices
will stop rising or may experience a small decline.
But there won't be anything close to a crash.
We also have to understand that the real estate market is not like the stock market that moves
up down every single day.
It's a well-established market that moves extremely slowly, and if anything like a crash
is on the horizon, it's definitely not happening this year.
No one knows the future, and I could be entirely wrong.
Since we have recently came out of a real estate crisis, it's difficult to imagine that
another one is on the horizon less 2 decades later.
Meanwhile, if you have a mortgage and you haven't refinanced yet then you are missing
an opportunity because getting a low fixed rate for 30 years is the best thing you can
wish for.
No matter what happens to the market, even those who didn't sell their houses back in
2008 still saw their houses rise in value over time.
So anyone who got a low fixed 30 year old mortgage rate should be fine in the long run.
By the way, we have a made a video on why everyone should invest in real estate on our
second channel where we have explored the hidden benefits of investing in real estate.
Please go and check it out.
Make sure you subscribe to that channel.
And now give this video a thumbs up if you have enjoyed it and subscribe if you are new
around here.
Thanks for watching and I will see you in the next one.