Here’s What Homeowners Should Do If the Housing Market Crashes
Written by
Andrew Lisa
Edited by
Emily Gadd
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A housing market crash is a sudden and substantial decline in home prices across a given market — a city, a region or even the whole country. Crashes often follow periods of inflated demand and rising prices, which create a “bubble” that eventually bursts.
For the homeowners whose wealth is tethered to the equity in those properties, market crashes are times of intense financial anxiety.
Causes of a Housing Market Crash
Several factors can contribute to a housing market crash, including:
- Economic recessions
- A rapid and widespread rise in unemployment
- Excessive lending to under-qualified borrowers
- Speculative buying
- Changes in interest rates
- Oversupply of housing inventory
Immediate Effects on Homeowners
The ripple effects of a housing market crash can touch every corner of the economy, from labor to the stock market, but the first and most immediate impact is on the homeowners themselves.
Decline in Home Values
A rapid drop in home values can force owners to sell at artificially deflated prices — even less than the purchase price, in the worst cases. If they can’t find buyers, they risk having negative equity with an upside-down or underwater mortgage when the balance of the loan exceeds the home value.
Increased Foreclosure Risks
Owners trapped in a market crash are more likely to miss mortgage payments because of unemployment or other financial pressures. Their homes become vulnerable to foreclosure, and foreclosures further deplete surrounding home values, creating a self-perpetuating cycle of decline.
Impact on Mortgage and Interest Rates
Homeowners with variable interest rate mortgages can be more likely to foreclose or have to short sell if their interest rates increase so much they have problem paying their mortgage.
On the other side, a housing crash can make variable interest rates very low. These homeowners would have an easier time making their payments.
Changes in Interest Rates
In times of economic crisis, central banks use interest rates as a stabilizing force, either making mortgages more expensive or more affordable.
Both can have unintended consequences.
High rates stifle buying and decrease purchasing power while making owners who lock in lower rates reluctant to sell. Low interest rates let buyers purchase more expensive homes and can flood the market with demand, which sends prices up.
Refinancing Challenges
Market crashes force lenders to tighten their lending standards as default rates rise. That can make it harder for qualified buyers to secure home loans and for current owners to refinance their existing mortgages.
Strategies for Homeowners During a Market Crash
Market crashes are inherently sudden, leaving homeowners little time to scramble for what is often the least bad solution. That is why it’s so important to think through the possible strategies and outcomes when the financial waters are calm.
Maintaining Regular Payments
The most immediate priority, is to stay current on your payments. Missing just one can damage your credit when you’re already facing financial strain and put you at risk of losing your home.
If you can’t pay, contact your lender immediately before missing a payment.
Exploring Loan Modification Options
Research the many options for modifying or refinancing your loan. Extending the term can lower your monthly payment at the expense of greater interest payments over time.
Considering Renting Out the Property
If it comes down to it, many homeowners can leverage their homes to generate extra income to stay afloat and cover mortgage costs.
If the alternative is losing your home, consider renting out a room to a tenant or using a platform like Neighbor.com or renting out a basement, attic or extra room as storage space — you can even rent your driveway as a parking space.
Long-Term Considerations
Housing market crashes cause widespread suffering, but many people also find opportunities to benefit in downturns — or at least ride them out.
Housing Market Recovery
The most recent housing market crash, and the most widespread and devastating since the Depression, was in 2008. Recovery was slow and uneven, but it didn’t last forever. Much of the market had fully recovered within six years or so, with many of those who stayed put enjoying significant appreciation in the ensuing years.
Although similar storylines played out in 1837, 1873 and 1929 — sudden and devastating crashes followed by prolonged recoveries — such nationwide cataclysms are mercifully rare. However, localized crashes can be more sustained and even permanent, particularly if a city’s or region’s economy is tied to a single industry that fails or relocates, as several Rust Belt cities experienced in the late 20th century.
Investment Opportunities
When home values plummet, investors can buy properties for less than they’re worth, giving them the opportunity to flip them or hold them if the market rebounds — but that’s a big if.
Accurately timing the housing market is as unlikely as timing the stock market, and buying low and selling high is easier said than done. If investors invest in unsellable or unrentable property in an area experiencing sustained decline, they could lose it all.
Protecting Your Home Investment
The decisions you make when purchasing and owning a home can determine your ability to endure a market crash.
Building an Emergency Fund
The surest way to survive a period of decline is to have a cash savings buffer to see you through the turmoil. Emergency funds, after all, are for emergencies — and housing market crashes definitely qualify.
Avoiding High-Risk Loans
Adjustable-rate mortgages are tempting because they offer lower rates upfront — but they can and do fluctuate as economic conditions change. In 2008, many homeowners who had been doing fine suddenly found themselves drowning in financial quicksand as their adjustable-rate loans adjusted up, up and up some more.
The predictability of fixed-rate loans provides security in market downturns.
Also, it’s your responsibility not to borrow more than you can afford, even if the bank is willing to lend it. The standard advice is to keep your debt-to-income ratio under 36%, but some lenders will issue mortgages to borrowers even if it bumps their monthly debt up to 43% of their monthly income, despite the financial strain such a burden is likely to create.
Regular Home Maintenance
As with all crisis-prevention strategies, homeowners should concentrate on controlling the things they can control. Keeping your property well-maintained and in good working order retains and even increases its value, giving you a leg up if the market declines.
FAQ
- What should I do if I owe more on my mortgage than my home is worth?
- If you find yourself with an underwater loan, you can continue making payments in hopes of a recovery and renewed appreciation, pursue a loan modification or cut your losses and sell. In all cases, it’s crucial to consult a financial advisor first.
- How can I avoid foreclosure during a housing market crash?
- Your lender doesn’t want to assume ownership of a distressed or unsellable property. It wants to collect decades worth of monthly interest payments from its borrowers. If you can’t pay, contact your lender, who will probably be willing to work with you toward a solution — but never ignore the problem or communications from the bank. At the same time, explore assistance programs from your local, state and federal governments or from those available through nonprofits or community groups.
- Is it a good idea to buy a home during a market downturn?
- Investing in a struggling housing market is a high-risk, high-reward proposition that is probably beyond the capacity of most typical investors. However, downturns can provide lucrative opportunities for those who have the knowledge, experience and capital — both to buy the property and to absorb the hit should they lose it all.
