A smaller house will make a big difference

@Money November 14, 2011: 1:19 PM ET
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(MONEY Magazine) -- Last year the economic forecasting firm Fiserv predicted that home values would sink around 5% in 2011, and that prices in three-quarters of the nation's major metro areas would fall. The bad news is, the firm wasn't that far off the mark. The good news: In the coming year, Fiserv thinks 95% of the 384 metro areas it tracks will see prices rise.

Don't expect the market to move much beyond first gear, though. The median expectation among more than 100 economists and real estate pros surveyed by MacroMarkets is that home values will inch ahead by a mere 0.25%, compared to their 2011 median forecast decline of 2.8%. They also foresee annualized gains through 2015 of just 1.1%, as the real estate market slowly works its way through a mountain of foreclosures.

Those foreclosures will continue to weigh on the market. According to Core- Logic, there are 5.4 million homes that are for sale or part of the market's "shadow inventory" -- which includes bank-owned properties, homes in the foreclosure pipeline that haven't hit the market yet, or properties where owners are seriously behind on payments.

To put that in perspective, Freddie Mac forecasts that only 4.8 million homes will be purchased in all of 2012. A market with six months of inventory is considered healthy. That there's more than a year's worth of housing stock now tells you what a tough slog this will still be. "It's analogous to a flood," says Mark Fleming, CoreLogic's chief economist. "The water is very deep in the living room, but it's no longer getting deeper and is starting to recede.

Helping that process along will be low-interest-rate mortgages that are expected to remain cheap. Jay Brinkmann, chief economist at the Mortgage Bankers Association, says the 4.2% rate on a 30-year fixed rate in late October might not last long. Still, he expects the 30-year fixed mortgage rate to stay below 5% throughout 2012.

The action plan: It will pay to think small -- as in reduce your mortgage bills and focus on modest homes.

Buyers: Downsize the dream.
For those gearing up to make a purchase, 2012 could be a great opportunity, what with cheap prices, low borrowing rates, and little competition among prospective bidders.

Before you take the plunge, remember that the price you pay matters, as does your ability to easily resell that home down the road.

Make Money in 2012: Jobs

This means it's best to focus on smaller properties in your area near restaurants and retail. McMansions of at least 2,600 square feet, which were the ideal in the boom years, are coveted by a mere 18% of households today, according to a recent survey by Trulia. And that figure could fall even more.

A separate survey by the National Association of Home Builders found that home-construction firms expect U.S. houses to average 2,152 square feet in 2015 -- down 10% from last year.

Some of this is attributable to the lingering effects of the past recession, which has eaten into housing budgets. But there's also a permanent change at play. "Baby boomers are trading down. They don't need the McMansion, and they don't want to drive as much," says Trulia chief economist Jed Kolko.

Sellers: Price it right. The longer you can wait for prices to stabilize in your area and for demand to pick up, the less likely you'll need to entertain low-ball offers. If you have to make a move in 2012, though, the trick will be to price your home correctly out of the gate.

According to a recent national survey of real estate agents, 75% of homeowners believe their house is worth more than what agents put the fair market value at, and nearly one in two homeowners still overestimate their home's value by more than 10%.

Meanwhile, Trulia reports that about one in four homes in its database has gone through at least one price reduction, and the average price cut for those homes is 8%.

Joe Magdziarz, president of the Appraisal Institute, says you and your agent should stick with comparable sales data just within the past 90 days, as that's what lenders expect appraisers to use.

What to do when mom and dad move in

If you don't trust your agent's recommendation, shell out $300 to $400 for an outside appraisal. That will be money well spent if it pushes you to list your home in sync with current market valuations and you sell faster.

Owners: Shorten your loan. Refinancing your old mortgage to a new fixed-rate loan could have you smiling for years to come. If there's any chance you can refinance into a 15-year loan, go for it; the 3.45% rate in late October was near an all-time low. On a $250,000 mortgage, going from a 30-year mortgage at 4.2% to a 15-year loan charging 3.45% would save you $120,000 in interest over the life of the loan.

What if the added $560 monthly payment is too steep to handle? Shop for a 20-year loan. The rate is likely to be only slightly less than on a 30-year loan, but the faster payback will save you in the long run.

Can't refinance because you don't have the 20% equity lenders typically demand these days? As long as you plan on being in your home for at least five years, look into a cash-in refinancing, where you bring some money to the closing table to push up your equity.

"If you can use cash that doesn't eat into your emergency savings, this makes a lot of sense," notes Michigan financial planner Gary Gilgen. "I'd rather have that money get my mortgage lower than have it sitting in the bank earning less than 1%." To top of page

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