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NEW YORK (MONEY Magazine) -
If the bursting of the tech bubble is seared into your memory, you'll tend to call up that readily available interpretive scheme as you analyze the surge in housing prices. Result: You see a giant ball of air.
That would be an eminently sensible conclusion -- if houses were stocks. Of course, they're not; they're bought and sold in particular local markets and infrequently traded and, well, you live in them.
On the other hand, if you're using interest-only financing to snap up condos in Fresno because you "know from experience" that this market only rises, good luck. Markets can suffer precipitous declines -- ask anyone who bought in Massachusetts in the late 1980s.
Even Alan Greenspan, a man utterly free of alarmist bias, recently warned that "the housing boom will inevitably simmer down" and that prices could fall.
The real bubble, though, isn't in housing but in housing finance, says strategist Ed Yardeni of Oak Associates. Variable-rate, interest-only mortgages have seduced people into buying more house than they need. (See "Crazy loans: Is this how the boom ends?")
Most at risk? Those who bought in late and are stretching themselves even to make their IO payments.
"These people could be in some serious trouble," says Yardeni, if interest rates rise or home values fall even on a modest scale.
What to do
Downsize. If you've used an interest-only loan to buy a McMansion when you can really only afford a three-bedroom split-level, get real. You're not building any equity, and if prices decline and you have to sell, you'll end up owing the bank. Also, if you're at a point in life when a smaller house is starting to look good, move now and secure your gains.
Think about what can go wrong. If you're counting on home equity to provide for your retirement, ask a financial adviser to assess what will happen to your plans if your home's value drops by 10, 20 or 30 percent, says Joe Davis, a research analyst at Vanguard.
Look at locking in. The gap between variable and fixed-rate loans has been narrowing as the Fed pushes up short-term interest rates. So grab a fixed rate of interest now. Waiting could add hundreds of dollars to your monthly payment.
Fear No. 6: Your identity is stolen
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Worried about housing prices? Find out how much house you can really afford.
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