What came first, falling home prices or a slumping market?

Chicken or the Egg?

While pundits galore will claim many different views, the answer is rather simple in economic terms. After years and years of record home price increases, the market simply couldn't support the increases anymore. Buyers could no longer afford the prices. House prices started falling first simply because no one was willing to pay the price anymore.

Most loan programs like to see debt ratios no higher than around 40% of income. FHA for example is 43%. Simple economics apply here. If the average wage in Minnesota (where I am at) is $784 per week ($40,784 per year), assuming no other debt (not likely), 5% down, PMI, taxes and insurance, this person could buy around a $180,000 home. Start throwing in debt, car loans, credit cards, etc., and the maximum home price starts sinking as fast as a rock in water.

As home prices increased, buyers started switching to high risk, short-term loan products to make homes more affordable. As we can see by today's market, that was a short sighted plan that didn't work out well for many.

Therefore there really is only one way to get demand up and people to start buying again. Affordable home prices. Simple supply and demand economics. Too much supply because of too little demand forces prices to drop. As unsold inventory clears, higher prices will return (but fewer sales).

Starting around 2000, the normal supply and demand cycle was dramatically upset as people threw caution to the wind and kept demand artificially high. Everyone wanted in, and they were willing to pay whatever price was asked. Everyone figured you could make a killing in the housing market. This was especially evident in the investment property market.

A killing has occurred. Just not the one most people expected as the house of glass broke in 2007.

So what do we do now?

BUY A HOME! Housing affordability has returned for most people, interest rates are near historic lows and there are deals to be had everywhere.