BEND, Ore. (CNN/Money) -
For now, mortgage rates are still near historically low levels. But more and more, economists are beginning to worry about a resurgence in inflation and thus rates. That, of course, would remove one of the key underpinnings of the recent boom in real estate.
Some economists have been incorrectly predicting higher rates for more than a year now. But now that Fed chairman Alan Greenspan has publicly declared higher rates inevitable -- without saying when -- it seems wise for homeowners to be thinking about the prospect.
Interest rates on 30-year fixed mortgages averaged 6.25 percent for the week ending June 24.
But what happens if rates start ticking up more quickly?
Watch out for rising rates
All things being equal, home prices could suffer when rates go up. After all, buyers who could afford a $1,400 monthly payment on a $250,000 mortgage when rates are 5.5 percent may not be willing to pay as much for a house if rates go to 7 percent, in which case the monthly payment would be $1,660.
"Let's imagine rates go to 7 percent, I think that would take the air out of the bubble pretty quickly," said Dean Baker, co-director of the Center for Economic and Policy Research,
Other economists say the relationship between home prices and interest rates isn't quite as direct. For one, when rising rates go hand-in-hand with an economic recovery, as they often do, better job prospects partially offset the effects of higher rates.
Also, when rates go up, buyers often opt for adjustable rate mortgages (ARMs), which have lower rates than fixed loans. "When rates started picking up after the last refi boom in 1993, people didn't leave the market, they just shifted into ARMs," said Eric Belsky, executive director of Harvard's Joint Center for Housing Studies.
(For more on how ARMs work and whether they're right for you, click here.)
Some markets, some homeowners, more vulnerable
Though there's never been a nationwide decline in real estate prices, individual markets have suffered plenty -- see "Real estate horror stories."
As such, some markets could surely feel more pain than others. "I'd be most concerned in places where housing affordability is an issue because the effects of rising interest rates are even more pronounced," said David Stiff, director of economic research for Fiserv Case Shiller Weiss.
"In cheaper markets interest rates probably won't matter as much as the local economy," Stiff added. "These are places where new supply matches new demand, and you just have steady appreciation."
According to the National Association of Realtors, existing home sales remain near record levels, but prices in individual metro markets were a mixed bag during the first quarter of 2004.
Of the 126 markets tracked by NAR, 35 had double-digit price increases over the past year. Prices in Riverside and San Bernardino counties near Los Angeles increased 32.9 percent to $258,900 between the first quarters of 2003 and 2004; prices in Las Vegas were up 31.3 percent to $224,900.
Among the 16 metro markets with price decreases, however, the losses were greater than in recent quarters. Median prices in Springfield, Ill. decreased 10.2 percent to $84,000 over the past year. In Charleston, WV prices sunk 9.8 percent to $99,600.
If you're not planning to move for years, a decline in home values won't have as much of an impact. But a decline could be a real problem for Americans who have taken advantage of the run up in prices to do cash-out refinancings. They could very well owe more than their house is worth -- bad news if they are forced to sell.
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