A housing bubble is a situation where there is an enhanced demand for real estate, especially housing, that is often created through artificial means, such as a lowering of interest rates. The housing bubble can lead to times of economic boom, but can also end in times of economic hardships. The key is to understand what creates a bubble, how best to combat it and how to ease any fallout from it.
One of the main reasons a housing bubble is created is due to a desire by a national bank, such as the Federal Reserve in the United States, to lower interest rates to spur the economy. This creates an interest by some to purchase real estate because it becomes cheaper to acquire that real estate. Therefore, demand goes up. Added to this is the practice of house flipping, in which a home is bought for short-term gain, and the market is further inflated by an artificial demand. As demand increases, prices increase -- substantially more, in some cases, than what may be considered the fair market value.
A housing bubble can not only create a good economic time for the real estate market, it can carry over into other areas. It can help construction companies, manufacturers of home appliances, electronics and other products, and infuse a substantial amount of money into the overall economy. In this way, it can create a good situation for the economy in a number of different ways, but this is likely to be a short-term situation.
The end of the housing bubble usually happens when interest rates are raised, which must happen if any country is to operate without crippling inflation. Bankers often call very low interest rates "cheap money." Therefore, when that money gets more expensive to borrow, there are fewer demand for homes. Thus, the housing market begins to slow.
Once the housing market begins to slow, there are a number of things that start to happen. The first is that requests for new mortgages begins to drop, followed quickly by housing sales -- both new houses and existing houses. Some new houses, built on speculation during the bubble, will sit vacant. Once those slow down enough, a reduction of price will take place as more sellers hope that a lower price will encourage potential buyers.
Just as there were very good times in the housing bubble, there will be very difficult times when that bubble bursts. However, the end of the bubble will likely see the market put back into equilibrium. Prices will return to fair market value and then begin a more gradual climb upward.
