Interest Rates and Your Real Estate Options

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Alan Greenspan, Chairman of the U.S. Federal Reserve Board, raised interest rates to 3.5% Tuesday

When the Federal Reserve hiked short-term interest rates a quarter-point this week for the tenth time since June 2004, one question many Americans probably asked was: should I sell my home now before the real estate bubble bursts?

It's only natural for folks to take interest rates personally. Even though mortgage rates have remained low through the successive hikes, some time (soon?) the ride is going to be over. Today, a 30-year fixed rate mortgage with no upfront points averages about 6 1/8%, according to Bestinfo Inc. — rising 1/8 of a percentage point on Monday — while adjustable rate mortgages are slightly lower. As short-term interest rates rise, so should mortgage rates — though nothing is certain about the real estate market anymore, it seems. Long-term interest rates actually declined over the past year, even as the Fed kept raising short-term rates.

Rising interest rates rise make borrowing money less attractive, leaving fewer buyers in the market. Barring some cataclysmic event that prompts emergency government action to rescue the economy, economists don't expect interest rates to decline any time soon. As Phyllis Rockower, home-investor and founder of the Real Estate Club of Los Angeles, says, "The easy money is over for now."

San Diego County in California is one hotspot feeling a real estate slowdown, but the trend has also been noticed in other major cities including Las Vegas, Denver, Boston and Washington. Once Southern California's hottest real estate market, San Diego is viewed as a bellwether or sorts, signaling trends soon apparent in other areas. Home prices in San Diego more than doubled over the past five years, soaring nearly 30% in one 12-month period. But lately prices have been rising much more slowly — only 6.3% on a year-over-year basis as of June.

Another sign of trouble: foreclosures are going up about 10% from a year ago, according to a survey released this week by internet database This marks "an uncharacteristic upward trend throughout the summer months," says Brad Geisen, president and CEO of the online service. "More significantly, we're seeing an increase in foreclosures in a majority of states. These blanket increases may indicate that factors such as weakening sustainable home ownership and the volatility of the housing market are beginning to add to geographic economic factors that contribute to foreclosures."

One reason for the foreclosure rise is the widespread use of so-called "interest-only" loans, which start out exceptionally low but which can jump suddenly and force homeowners to bail on their properties. When some interest-only mortgages start to amortize, monthly payments can increase by thousands of dollars. In places like Denver, Colorado, where an estimated half of all home loans made last year were of the interest-only type, that can spell disaster.

Rockower strongly suggests homeowners with adjustable-rate mortgages who plan on staying in their current residence shift now to a fixed rate. "Anybody who doesn't have a fixed-rate loan is an idiot," she says. And, if you're holding onto real estate strictly as an investment, she believes it's probably the right time to cash in. It's not just rate hikes that concern Rockower. "Interest rates don't have to go up one dime for the market to collapse," she says. "All those teaser rates and no-money-down deals that people used to buy property are now starting to adjust, and it's causing real havoc."

Rockower's not the only person to believe the sky is falling: Princeton economist and New York Times op-ed columnist Paul Krugman this week wrote that "we're starting to hear a hissing sound, as the air begins to leak out of the bubble" in the real estate market. Don't expect a plunging decline, says Krugman; instead, continual falling sales and rising inventory are signaling the end of good times. In other words, the bubble won't burst, but pfffffffffffffft gradually out of air.

Rockower and Krugman may, of course, be proven wrong, and the real estate market could continue to climb for some time to come. As with stocks, bonds and other investments, it's often difficult to make blanket statements about the entire real estate market, especially since home prices vary wildly in different cities, states and regions. But, considering the rising tide of interest rates, now seems a perfect time to assess your real estate holdings and home loan with an accountant or mortgage broker, just to make sure you're on the right track.