A hot housing market, also called a seller’s market, happens when demand for homes is greater than the number of homes on the market. Competition among buyers is fierce, with bidding wars and houses being snatched up as soon as they are put up for sale. As with any commodity, this pushes prices up.
Desperation sets in for some buyers and they up their risk by bidding beyond their budget, waiving contingencies, or taking on more debt than they can safely afford. Some will do just about anything to get into a house.
Soon, asking prices are way over what homes are actually worth—but buyers are buying anyway. And just like a bubble, the market can take only so much of this pressure before it bursts.
A number of different economic factors can be responsible for bursting a real estate bubble, which forces supply and demand back into balance. Increasing interest rates will make it harder for people to get financing, especially for homes with exaggerated asking prices. A general economic downturn tends to mean less disposable income and possible joblessness. If people can afford to buy at all in this market environment, they are typically less willing to take risks. All of these things combine to reduce demand. As a result, prices will drop too, and home values along with them.