The 2008 housing crash was the result of a perfect storm, fueled by reckless lending and blind market confidence. Today, we have stricter underwriting and tempered attitudes, yet 60% of Americans believe we’ll enter a recession in the next year, according to NerdWallet’s Consumer Financial Resilience Index.
That fear isn’t entirely unfounded. On average, economic crashes happen every 10 to 15 years, says Cosmo P. DeStefano, a retired CPA and former tax partner at PwC. “You're going to see it over your lifetime a few times.”
So, if uncertainty is the only certainty, how can you really prepare? I spoke with three financial experts who experienced the 2008 crisis firsthand and learned lessons that still apply today.
Patience can be more valuable than equity
In 2006, Kevin Watson, branch manager and home loan specialist for Churchill Mortgage, had just built a new house outside of Nashville, Tennessee.
“We had a sizable down payment, but not huge,” Watson says. He planned to be in the house a couple of years and opted for an interest-only adjustable rate mortgage (ARM), which keeps early payments low since you’re only paying the interest (an increasingly popular option leading up to the 2008 crash).
The trade-off is that you’re not building equity ... a reasonable risk if everything in your life and the market remains stable.
But when the housing crisis hit, foreclosures spiked, inventory surged and home values dropped. Suddenly, equity was the lifeboat that many, including Watson, didn’t have.
“We ended up pretty much what they call underwater, meaning your mortgage was bigger than your value,” Watson says. And he wasn’t alone: 11.59% of housing units were underwater in 2009 — more than double the figure from 2007 (4.83%), according to the U.S. Census Bureau.
Unable to sell the house, Watson rented it out to help cover the costs. He eventually moved back in, mortgage-free, which led to one of his biggest lessons.
“It's not about timing the market, more about the time in the market,” Watson says. Risk can be easier to balance if you have more than one exit strategy, as well as the flexibility and patience to ride out the dips.
Today, we're short on inventory, Watson noted. If rates drop, more buyers qualify, demand increases and prices go up. This might push buyers to stretch their finances to get into a home — again, a reasonable risk if everything in your life and the market remains stable.
Sound familiar? It’s not the same storm as 2008, but there are similar weather patterns. Knowing how much of a risk you can take comes down to your own tolerances and budget.
Calculating your debt-to-income ratio (DTI) is a great jumping-off point to understand how much risk you're taking on. Lenders typically prefer a DTI of 36% or less, but this figure is as much a guide for you as it is for them.
Letting go is a financial superpower
NerdWallet Senior Economist Elizabeth Renter bought her first home in 2006.
“As a first-time buyer, I qualified for down payment assistance and put nothing down,” Renter says. “The mortgage was more than manageable between two incomes.”
But when the crisis hit, it wasn’t falling home values that delivered the biggest blow — it was going from a two-income household to one in 2007.
“I struggled to make the payments,” Renter says. “My house became unaffordable because the household income changed, not necessarily because the market changed.”
Renter battled with the decision to “do something” for a few years before reaching out to someone about short sales. A short sale — selling a home for less than what's owed on the mortgage — is typically preferred over foreclosure since it's less costly for lenders and less damaging to the borrower's credit.
Many homeowners in the years after the housing crisis took this route, leading to a surge in short sales. In 2012, 7.7% of sales were short sales compared to 0.6% in 2006, according to transaction data from Cotality.
“The thing preventing me from moving forward sooner was pride — I was embarrassed that I had to let my home go,” Renter says. But sometimes you have to separate those feelings from the facts and make pragmatic decisions. “If it no longer makes sense for you to live there, it’s OK to let it go and move on.”
“The first person I approached with my problems was my former real estate agent. I knew she was a pro, and I didn’t feel the shame I might have felt bringing my family and friends into the fold,” Renter says. The agent referred Renter to a short sale expert and the house was sold in 2012.
“I realized I hadn’t done anything wrong, but my conditions and those in the economy around me had changed,” Renter says. Her experiences transformed her perspective on what a "home" means — she’s since bought again and also rented.
“Living somewhere new feels like an adventure rather than a measure of success," she says, "and this perspective helps me focus more on what matters.”
Follow your gut, not your neighbor
DeStefano, the retired CPA, bought his home in 1998 with his young family.
“It was our first mortgage and we had just had our son,” DeStefano says. “We stretched to what we thought we could do and we charged in.”
In the late 90s, the 2008 housing crisis was just a twinkle in the economy’s eye and market optimism was high. But despite the bull mindset, DeStefano decided to pay aggressively into his mortgage instead of investing — a move that shocked his peers.
“As a raise came or if a bonus came, I would actually add more money to my monthly payment,” DeStefano says. “Pre-paying was just a piece of the bigger picture… I knew where I wanted to go, and I knew market crashes were going to happen.” When the crisis hit, DeStefano kept to his plan and took advantage of the falling interest rates.
“I just started refinancing,” DeStefano says, noting that he still kept paying more than what was due despite securing lower mortgage rates.
In today’s market, refinancing typically makes sense when the rate is at least 0.5 to 0.75 percentage points lower than your current one. Another key metric to know is your loan-to-value ratio (LTV) — the amount you’re borrowing compared to your home’s value. The lower your LTV, the less risky you look to lenders and the more likely you’ll be able to secure lower rates.
DeStefano eventually paid off that mortgage and is still in the house today, attributing his success to the clear, personalized plan he’d had from the start — “personalized” being the operative word.
“You need to find what works for you, not what works for the guy next door or the girl sitting across the office from you,” DeStefano says.
We all have different ambitions and comfort levels when it comes to finances. Sometimes that means going against popular trends, being patient in the face of uncertainty or not letting shame dictate your decisions. Whatever the journey, get up close and personal with your money. Even if you can't control the weather, financial awareness can be your lighthouse in the storm.
The article A Broker, Accountant and Economist Walk Into a Housing Crash — and Walk Out Wiser originally appeared on NerdWallet.
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