Ever wondered what drives real estate markets and prices?  The answer is relatively simple:  supply and demand. However, understanding the factors behind supply and demand takes a little more time.

Demand goes up when loans are easy to get

During the past several years, subprime loans were relatively easy for consumers to get. Subprime lending is also known as “second chance lending” or “non-prime lending.”  Essentially, it’s a term that characterizes the practice of financial institutions lending money to borrowers who do not meet standard or “prime” underwriting guidelines.

Most subprime loans are described as loans given to borrowers with credit scores below 680. Credit scores in the 600-range generally characterize individuals who are risky as borrowers because they are less likely to pay back financial obligations than those with scores in the 700s.

The argument for subprime lending is that it opens up credit to individuals who would otherwise not qualify as borrowers. This offers those individuals the chance to move forward and become homeowners, ideally pulling themselves up out of financial strife. In order to get these, subprime borrowers usually pay higher interest rates and have other stipulations added to the terms of their loans.

The argument against subprime lending is that it’s a risky venture and that the likelihood of subprime borrowers to pay their mortgages on time and in full is low.

Nevertheless, because so many people were recently able to qualify for mortgages through subprime lending processes, the demand for housing increased. An increase in demand meant sellers could increase their prices. Such a situation can drive real estate prices to sky-high levels.

Investors can add to rising market prices

Not all of the recent demand for housing was due to buyers with subprime loans. A large number of investors also played a role in driving up market prices because they added to the overall demand for housing across the country.

Even though investors are typically backed by solid monetary resources and bring little financial risk to the market, their high demand for housing helps to drive prices up.

Why the “housing bubble” can “burst”

If you think of the housing market as a bubble, imagine that all the demand for houses simply pushes more and more content into that bubble. The bubble grows larger and stretches thin, and then when it is past capacity – that is, when there is no more room for new housing demand – it “bursts.”

When a housing bubble bursts, it means that the market is transitioning from a seller’s market to a buyer’s market.

To clarify, a seller’s market favors sellers because they are able to ask top prices for their homes with the assurance that plenty of buyers will be willing to pay that price. A buyer’s market, in contrast, occurs when there are more homes for sale than there are buyers. This means sellers have to be more competitive in their pricing because buyers have plenty of other options.

How subprime loans drove the housing market down

Because so many lenders recently offered subprime loans to less-than-qualified borrowers, a higher number of borrowers began to default on their loans. By paying late or not paying their mortgages in full, these borrowers gradually fell into a state of foreclosure, repossession, or even bankruptcy.

As the number of negligent homeowners increased, the number of foreclosed homes increased. This led to a rise in available housing on the market which gradually translated to a buyer’s market. As is typical in a buyer’s market, housing prices plummeted from their previous highs.

Housing markets are cyclical

Though the U.S. housing market is currently in a state of decline, it’s almost guaranteed to go back up again. Just as supply and demand drive real estate markets and prices, that demand is cyclical. The excess in housing availability will gradually lead to more buyers snatching up houses, which will lead to a decline in availability, or supply. As supply goes down, demand goes up, once again creating a seller’s market.

The secret to navigating the housing market is a combination of patience, research, and sound financial habits. Get your own financial priorities in order before applying for a home loan. Search out the best loan you can find, preferably one at a 30-year, fixed rate. Attempt to buy a new home when the market has a high supply – this will afford you a better purchase price. If you ever need to sell your home, try to wait out market forces until you’re in a seller’s market and you can ask for top prices.