3. ELI5: The housing market. Why is it broken and what happened for it to get that ...

ELI5: The housing market. Why is it broken and what happened for it to get that way?

I posted a comment earlier, but realized I didn't like the wording. Let me retry.

You want a house and apply for a loan (mortgage). A loan is a risk so to ensure you can the mortgage, the bank checks your background and ensure a few of the following things.

1) You have a stake in the house and have your own interest in its well being (downpayment) 2) You have a good credit rating 3) Have decent income and net worth.

Great! You're reliable and get the loan. The prices of houses just keep rising and rising. Perfect for YOU since you're paying a mortgage on a house that will be worth more than what you payed for AND perfect for the bank since they have reliable collateral (your house). Low risk for you and for the bank. This is okay.

Now comes the bubble and politics. Under the assumption that housing values are going up, loans are given out to people who aren't as "reliable" as you. They are called sub-prime mortgages. Now, you would think you're introducing "risk" to investment right? Well, at the time it was deemed that way because as I said earlier, housing prices are increasing so the bank has collateral. If the unreliable guy defaults on his loan, the bank still has a great house that rises in price.

Okay, so far its cool. Now, we've hit a saturation point where there's really nobody left. Demand for houses is dwindling because there is a limited amount of people AND the risky unreliable guys not surprisingly start defaulting on loans.

If demand stop risings prices plateau. Not only that but supply is increasing too now that houses are for sale that were previously loaned to risky borrowers. Less demand, more supply....decreasing prices. Now you, the reliable borrower sees the values of houses around you go down in value...guess what...your house does the same. So you don't want to pay a mortgage on a house worth less than your loan so you walk out too. Now supply is increasing like crazy, demand is decreasing like crazy and therefore price is falling. Falling prices mean all the confident investments in the real estate industry (which is huge) are now worthless and it ripples to the n'th degree.

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