The Housing Crisis
What was the housing crisis? And more importantly, why should you care? Since when does the U.S. economy deserve a spot on your list of stuff to worry about?
What Is It?
Let's tackle the what first.
The housing crisis had two things going on:
- Lots of individual people getting into trouble with their mortgages.
- The financial system as a whole getting into trouble with lots of mortgages.
Let's say you buy a house for $500,000 by taking on a mortgage of $450,000. You spend four years cutting back on dining out and going to the movies; all those lost date nights are worth it because you've paid down $20,000 of what you owe, and the bank only has you on the hook for $430,000. (Only.)
Feels great…until you realize the market value of your home has dropped to $385,000.
The scariest word in the English language. (Source)
If you don't plan on moving, maybe you're not too worried. After all, what goes down must go up.
But then you lose you your job. And there are no jobs in town for a horse-shoer…or for anything else you'd want to do. And since you couldn't throw a 100 MPH curve ball, you can't do that for a living either.
Good news: there's a job at your company three states away. Starts in three weeks and the pay is the same. You breathe a sigh of relief, especially since your S.O. can get a job three states over, too. You won't lose any money.
But hold on.
You can't take your house with you (unless it's a trailer, in which case you have the last laugh). And that drop in value suddenly matters a whole lot.
Selling Homes in a Crisis
The house is "officially" worth a market value of $385,000. The good news is that it gets listed for $425,000 because market price is what the home would close at.
One tiny problem: some of your neighbors have also lost their jobs or can't keep up with their mortgages or just get cold feet at dropping property rates and decide to get out. Your buyers have their pick of the lot in a buyer's market, and the Smiths down the street are willing to drop the price on their home to get it sold faster.
You need to move so you negotiate. You and the buyers decide on $385,000. But then there are repairs you're liable for. You forgot to clean the eaves one winter, and half the gutters froze and fell off. That pesky raccoon made a hole in the roof you meant to repair. Remember that time you tried to move your piano in through the bathroom window? You had to know it would come back to haunt you. That's about $5,000 in repair costs and closing costs.
So you've got $380,000 in your pocket.
Don't breathe a sigh of relief just yet. That happy and smiling real estate agent who got your house sold has to be paid. Realtors are paid on commission, usually about 5%, so that's $19,000 less from your sale. No wonder that realtor was so cheery.
Now you've got $361,000 from the house in your account.
The realtor may be happy, but your banker probably won't be. You owe the bank $420,000 on your mortgage and they won't just take an IOU on the rest. And did you read the fine print on your home loan? There are pre-payment penalties if you try to break the mortgage or pay it off faster. Those can be about $5,000, meaning you owe the bank $425,000 but you only got $361,000 for the house.
You're about $63,000 in shortfall (or "in doo-doo," to use a more technical term). Bankers call this being $63,000 underwater. You may think that it's hard to breathe when you owe that much, but what happens when millions of people across the country are underwater for that much or more?
More importantly, how are you going to pony up $63,000 for the bank? Kidneys don't sell that well during an economic downturn, and yours have a low resell value anyway because of all the stress.
Maybe you have some savings in investments. You've been saving for years and years for something fun (like a Porsche for when your mid-life crisis eventually hits). You have $20,000, but your investments have a low tax basis, which means that if you decide to sell your investments, the government will want $2,000 in taxes on the $10,000 gains on your investments. So you only get $18,000 in cash from your investments, and it stings to know that you might not be able to afford a red sports car when you're feeling insecure and wrinkly.
And you still owe $45,000 to the bank. How will you get that cash? Another bank is unlikely to lend you the money. You might be able to arrange to have the $45,000 bundled with a second mortgage deal on a new house, but that's going to cost you a lot because the seller of the new house is loaning you money—and they want their share of the pie.
You could save up the $45,000, but with your imminent move, money's going to be tight for a while.
You could just tell the bank, "We can't pay. You keep the house. Here are the front door keys and the alarm code. You figure it out." Well, you can do that, but banks are corporate and legal creatures, and they will file all the forms that go with a bank repossession—meaning that if you ever go out for credit again to try and buy a home, say, a decade later, the next bank you ask for money will likely… pass.
They might even laugh in your face a little.
The Bigger Picture
Between 2008 and 2009, millions of Americans went through that kind of mess—and some are still paying for it today.
When one person loses their house or walks away because they're underwater, it's sad. But when a significant chunk of America goes through something like that at the same time?
Economic meltdown. Banking crisis. Housing bubble.
People freaked out at the banks when all this happened because all those stories of people losing their homes were part of a bigger, more ominous picture.
Banks make money by lending money to others. When you bring $100,000 to the bank, the bank just doesn't stuff it into a sock drawer in the back. No, they lend it out to the next guy who comes in to borrow $100,000 for a house. He pays them back (with interest) and the bank makes money and pays you interest on your savings account. Banks even do all kinds of fancy investment things (like bundle mortgages together and sell them for profit) to make even more.
And mortgages seemed like a great place for banks to invest. For hundreds of years, housing prices in the United States went up. When something happens for hundreds of years, you tend to expect it to keep happening.
Like a balloon, housing prices got bigger and fatter and bigger, until one day they just…popped. Housing prices went way, way down. How low? Well, in what's called "the sunshine belt" (Los Angeles, Phoenix, San Diego, and surrounding areas) housing prices dropped by half between 2008 and beyond.
If you owned your house free and clear and didn't want to sell right away, that didn't matter much. But if, like many people, you had a huge mortgage and suddenly were out of a job?
Why it Matters to You
2009 was a long time ago. We've all moved on. And if you're not selling your house for ten years or more, there's plenty of time for housing prices to head back up, right? Maybe you don't even own your own home yet, so you think it doesn't concern you at all.
Well, you might still be feeling the repercussions. The housing market doesn't just affect houses. When the housing bubble burst, a lot of people lost money and a lot of jobs said bye-bye. Because houses were worth less, fewer developers were interested in building more homes, which meant that a lot of people in the construction and real estate investment industries lost their jobs. That trickled down, and pretty soon, lots of other folks were losing their jobs, too. Some people still haven't gotten back on their feet.
Your parents may be slightly less financially secure than they were back then if they lost money in stocks. You may have to look for scholarships now if your trust fund was lost in the fray or if the 529 Plan they set up for you was used to pay the bills.
For many people, their home is the largest asset they have in their retirement years. For plenty of Americans, that was ripped away—and some are still struggling to buy a home. Since banks contributed to the process by offering mortgages to just about anyone, they had to tighten up their mortgage rules. That means when it's your turn to buy a house, you'll have to face stricter rules and jump through more hoops to qualify.