NEW YORK (CNN/Money) - There are five words guaranteed to freeze the blood of most prospective home buyers: "You're buying at the top."
Sure, mortgage rates are at historic lows, but if you're on the hunt for a home in areas where housing prices have soared, you face a dilemma: If a housing bubble exists, as some have suggested, you risk paying top dollar for something that may drop in value; if we're not in a bubble and home prices continue to climb, you feel pressure to buy now before you're priced out of the market.
When you're putting your money on the line, sleeping on nails is more relaxing than making this kind of call.
So maybe it would help to confront your worst fears. (And then realize why all is not necessarily doom and gloom even if you do pay top dollar.)
Okay, here it is, your home-buying nightmare: Prices plummet in your new neighborhood as soon as you tip the movers and they don't recover for years. Not only does your home fail to appreciate, you end up owing money to the bank when it comes time to sell. Oh, and to add insult to injury, you won't even be allowed to deduct the loss on your taxes.
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Here's a second nightmare: Prices in your new neighborhood flatten and tread water for years. Your home doesn't appreciate enough for you to recoup the transaction costs of buying and selling. If you're lucky, the equity you've accumulated by paying off your principal will cover those fees so you won't owe money before walking out your front door for the last time.
The chances of either of these scenarios occurring, at least judging from the national picture, are not high. Since 1968, national home prices have increased an average 6.3 percent a year, according to the National Association of Realtors. And most often, said NAR spokesman Walter Moloney, homeowners acquire enough equity in their homes to trade up to a better house or to pad their nest egg.
That is not to say, however, that real losses -- the loss after factoring in transaction costs and inflation -- can't occur. A study looking at homes sales in Philadelphia, Boston, Chicago and Denver by the Joint Center for Housing Studies at Harvard University found that real losses were "remarkably common" for homeowners who bought and sold their homes between 1982 and 1999. In Philadelphia, for example, 78 percent of homes sold in 1998 that fit the study's criteria yielded a real loss for their owners.
Another study by the Center found that people who bought homes in 1991 in Los Angeles, one of the most cyclical markets in the country, would have had negative equity by 1995 in both higher- and lower-income neighborhoods. Put another way, a homeowner who put down $100,000 in the top 10 percent of neighborhoods by income was likely to have minus $18,048 in equity by 1995. Homeowners who purchased in a low-income neighborhood would have seen their equity drop from $19,606 to negative $3,224.
Work on your timing
Of course, you only suffer a loss if you actually sell. If you're living in your home when prices drop "you've only lost money in theory," said Ray Brown, coauthor of "Home Buying for Dummies."
That's not to say there are no consequences to losing equity while living in your home. For example, you may not qualify for a home-equity loan or line of credit until prices start to appreciate again. But on the bright side, you're still likely getting a tax-writeoff and you have a roof over your head.
And even if you live in a volatile housing market, buying at the top may not be the worst thing.
When it comes to real estate, "people say it's location, location, location. But when it comes to your return, it's timing, timing, timing," said Eric Belsky, the Joint Center's executive director.
The longer you stay in your home, the better your chance of riding out any down drafts and profiting from the next upward trend in housing prices. That is, you may buy at the top of one market, but sell at the top of the next one.
Typically, a correction in an area's home prices occurs after several years of double-digit growth, Moloney noted. Following the run-up, prices decline for a couple of years, flatten, then begin to increase slowly.
The people who should be most worried about buying at the top are those who know they'll be moving in a few years or those who intend to invest in a home hoping to make a quick buck, said certified financial planner Doug Flynn of New York. "If you're buying a home you're going to stay with for a long period of time, it doesn't matter when you buy," he said.
Buying at the top is also less of a concern if you're going to be staying within the same real estate market when you do move, Belsky said.
That's because even if prices drop and you sell your current home at a small loss, you may be able to purchase a better one at depressed prices. When home prices turn north again, you'll be living in a more valuable home and may make more of a profit than had you ridden out the drop in your first house, Flynn said.
Minimize your risk
No one can identify with certainty the top of the market, Brown noted. Nor can you predict whether you'll ever lose your job, be transferred or experience a financial setback that forces you to sell your home.
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But there are factors you can control that may save you some grief down the line.
For example, you don't want to buy too much house or too little. In other words, don't stretch yourself so thin when buying a home that if one thing goes wrong your financial life collapses like a house of cards. At the same time don't buy a home just because you can afford it but know you're going to outgrow in the next few years.
Also, Flynn said, "don't bank on some appreciation to parlay you into an intermediate term house." Your house may appreciate enough to bolster your next down payment, but if it doesn't, you may need to take it upon yourself to set aside savings to make your next move.
And if you can, avoid moving to an area closely tied to one industry because if that industry takes a hit, so, too, will home prices. You're better off buying in an area with job growth and job diversity, Brown said.