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Don't panic yet

August 26, 2006

REPORTS ABOUT THE HOUSING market have been downbeat for homeowners all summer, especially in Southern California, with fewer deals closing and the supply of unsold units mounting. So the latest readout from the National Assn. of Realtors -- fewer homes sold in July than in June, average sale prices dropping in several regions -- was yet another sign that the market's jet engines have run out of fuel.

It's too early to say whether the slowdown will turn into a crash presaging a recession, as happened in the late 1970s and '80s, although the economy's other fundamentals remain healthier now than then. But it's worth bearing in mind which homeowners are most likely to be affected by a possible downturn and which ones can lay off the antacids.

Homeownership in the U.S. is at its highest level in at least 110 years, with nearly 70% of the population in 2003 living in residences they own. That increase over the 65% rate of just a decade ago is widely attributed to not only an aging population but to innovative lending techniques that have enabled more young people to buy instead of rent. Those techniques include zero-down-payment mortgages and "sub-prime" loans to people who in the past would have been considered too risky.

Within this enlarged pool of homeowners, many of whom have a thinner financial cushion, there are two groups: those whose homes are a long-term investment, and those looking for a quick resale. The first group can shrug off anything short of a calamitous drop in prices, even if they sell their homes during the slump. That's because they've benefited from the outsized run-up in prices since 2001, when home values in Southern California rose 11% to 23% annually. Buying a home is typically a good long-term investment for a variety of reasons, but earning stock-market-like growth is not one of them.

Recent home buyers who have counted on big short-term gains have more to worry about. Speculators already have recognized the risk and retreated from the market. But numerous other buyers had been hoping to work their way up to bigger homes and better neighborhoods. A burst bubble could force these people to stay put for several years.

A separate point of anxiety is the prospect of higher interest rates for buyers with adjustable-rate mortgages. The Federal Reserve recently took a break from its prolonged increasing of short-term rates, but lingering risks of inflation could push borrowing costs, and therefore adjustable mortgages, back up. Owners who can't afford the higher payments might be forced to sell their homes at a loss.

Meanwhile, though, there are nuggets of good news for would-be buyers, especially those who have been priced out of this market. With demand for loans dropping, some banks are making it even easier to obtain mortgages. Homes are staying on the market longer, and sellers' expectations are fading. But if you're going to buy a home, you'd better count on keeping it for a while.

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