Housing Bubble

Guide Note:

The housing bubble refers to the increase in housing prices relative to interest rates and personal incomes. Once real estate values reach inflated levels, as compared to personal income, the bubble can collapse, resulting in a marked increase in loan defaults

Fast Facts:

1. Cyclic in nature
2. Important indictors of a housing bubble: valuation component and leverage component
3. Valuation component: A measure of the price of housing relative to income
4. Debt component: A measure of the amount of indebtedness taken on after the purchase of real estate
5. A global phenomenon seen in various economic/political environments

• Price to Income Ratio = Price of Real Estate / Household Income
  • The price to income ratio takes into account the affordability of real estate relative to income. It is a primary measure used by lenders to gauge the ability to sufficiently pay down a loan.
• Median Multiple = Median House Price / Median Annual Household Income
  • An economic indicator as to whether housing prices are misaligned with the income of a given area. Historically at around 3.0, periods during housing bubbles have seen numbers in excess of 6.0.
• Loan to value = Dollar Amount of the Loan / Appraised Value of the Real Estate
  • A measure used by lenders to assess the risk of a loan. The higher the percentage the more risky a loan. For example, a if a borrower wants a loand of $200,000 on a property worth $250,000 the loan to value (or LTV) is 80%.