The Housing Crisis Explained - A Guide for Home Buyers

by Brandon Cornett

What is going on with the U.S. economy right now, and how does it affect people who are trying to get a mortgage and buy a home? This explanation will give you a better understanding of the economic and housing crisis in this country, as it pertains to people who are trying to buy homes.

This article was written in October 2008, a time of economic hardship and uncertainty in the United States. The housing crisis has grown into a full-blown economic crisis, and it has changed the "rules" of home buying. As a result, home buyers in this country have become increasingly confused and frustrated. Many are having trouble qualifying for mortgages, even when their credit scores are decent.

But based on the emails we receive at the Home Buying Institute, the biggest frustration among consumers in general (and home buyers in particular) comes from a lack of understanding. Many people simply don't know how we got to this point, what the housing crisis means to them, and where we are headed in the future.

I can't help with future aspect of it -- my crystal ball is broken at the moment. But I can help you understand the history of our housing crisis and how it affects you in the present. Let's start by taking a look back...

Planting the Seeds of a Crisis

Real estate is a perpetual cycle of ups and downs. But once in a while, certain factors combine to create a "perfect storm" of housing bust. This is what we are seeing now. But while many factors have led to our housing crisis, most economists point their fingers at one cause above all others -- the subprime mortgage market.

As the name implies, a "subprime" loan is one given to a person with a bad credit score. Because of this low score, the borrower will not qualify for the best interest rates and will be given a rate that is below prime, hence the term subprime mortgage.

Now take this concept and multiply it many thousands of times over, and you will begin to see what caused the housing crisis in this country. Despite warnings from economists in the mid 1990s and early 2000s, these subprime loans were given out in staggering numbers.

Often, the lenders would downplay the risks associated with them, and would offer a low "teaser" rate for the first few years of the loan. After the adjustment period, however, the interest rate on the loan would skyrocket. Many people found they could no longer afford their mortgage payments. So then we saw record numbers of home foreclosures sweeping across the country.

This is not an article about who's to blame. But, if forced to point a finger at somebody, I would say the blame could fall equally onto three groups:

1. The home buyers / borrowers who did not do enough research (blinded by the desire to own a home).


2. 2. The lenders who downplayed the risks of subprime ARM loans (blinded by greed).


3. 3. The federal government who looked the other way (blinded by all of those campaign contributions from the lenders).

What This Crisis Means to Buyers

So we have explained the primary causes of this crisis. But what does this housing crisis mean to you, if you're planning to buy a home soon. For one thing, it means you will need a better credit score to (A) qualify for a home loan and (B) get the best rate on that loan. Tougher regulations were put in place as a result of the housing crisis, and these regulations do what should have been done years ago -- they discourage banks from lending to people with bad credit (among other things).

On top of that, we are seeing financial institutions fail because of all the bad loans they made in the past. So banks today are a lot less inclined to make what they feel is a risky loan.

Let's assign some actual numbers to this explanation so it makes more sense:

I recently saw Jean Chatzky, the financial editor for the Today Show, describing how the housing crisis has affected borrowers, in terms of their credit scores. She explained something we have already talked about. Home buyers today need better / higher credit scores to qualify for mortgage loans. She then backed this up with numbers that were derived from polls of the lending industry.

• In May of 2006, a borrower needed a credit score of 620 or above to qualify for the best interest rates on a mortgage.


• Two years later, after the housing crisis and all of its fallout, borrowers would need a score of 760 or above to qualify for the best rates.

That's a significant change, and it shows you how this crisis affects buyers who need mortgage loans. The bottom line is that banks are not taking any risks with subprime loans or borrowers with bad credit these days. As a result of the housing crisis, the bar for mortgage qualification has been raised.

What Can You Do?

I frequently get emails from people who say something like this: "I have bad credit but I want to buy a home. How should I go about it?" In other words, these people are asking how to get a subprime loan. Evidently, they do not watch or read the news.

My response to such questions is always the same -- don't do it! Buying a home with bad credit is virtually impossible right now. And even if it were possible, it would be the worst financial move you could make in this economy. People with bad credit should "hunker down" and focus on improving their credit scores before they do anything else. Wait until the housing market shows signs of recovery. Wait until you have the kind of credit score that will allow you to qualify for a loan, and to get a decent interest rate on that loan.

Good Deals for Buyers With Great Credit

But what about home buyers who have excellent credit? Ah, now we are getting to the ray of light in all of this gloom. If you have solid credit, you could actually benefit from the effects of the housing crisis explained previously.

As we discussed, there are fewer buyers today because of the tighter lending standards. People are having trouble qualifying for mortgages. There are also more homes on the market, because so many homeowners have to sell in order to avoid foreclosure. High supply and low demand creates a buyer's market, and this is exactly what we are seeing in many cities across the U.S.

So if you are a buyer with excellent credit, you could get a good deal on a home right now. Of course, no one can predict what will happen to the value of the home after you buy it. But at least now you can go into it with a better understanding of how the housing crisis affects you.

* Copyright 2008, Brandon Cornett. You may republish this article if you retain the citation notes and hyperlink below.

Citation Note: This article was created by Brandon Cornett, publisher of the Home Buying Institute. HBI offers consumer advice on mortgage loans, home buying, credit information and more. Learn more by visiting: http://www.homebuyinginstitute.com

Chris Farkas is a Realtor with EXIT Realty in Bellingham, WA