Protecting yourself if home prices fall

Chicken Little may be right. But don't worry about it.

The housing market is getting a little wild in some places, with folks trading condominiums like they are individual stocks, one Florida market soaring 46 percent over the past year and buyers resorting to interest-only mortgages to afford homes.

Danger ahead? A slump in property prices might hurt speculators. But if you are an ordinary homeowner, I wouldn't be overly concerned — provided you have enough money for your next down payment. Here's why:

• Moving markets. Despite all the talk of a housing bubble, many places have enjoyed only modest gains over the past five years, as you can see from the accompanying chart.

"The housing markets are not that crazy," contends Chris Mayer, director of Columbia University's Milstein Center for Real Estate. "I think it's a very narrow group of people who should be worried. It's high-end properties in New York, Florida and a couple of California cities. Outside of that, I don't think there's a bubble."

Still, suppose you live in one of these markets, are convinced that property prices will crash and want to protect yourself. Are you going to sell your home, move the family into a rental, and buy again in a couple of years? Even if property prices tumble, it might not pencil out once you figure in rental and moving costs and the cost to buy and sell real estate.

And if prices do slide, there could be a silver lining. Let's say you plan to stay in the same area, but you want to trade up to a bigger home. True, if prices drop, you would lose on your current house, but in all likelihood, the price of more expensive homes would suffer more, so trading up would be less of a stretch.

On the other hand, if you own a house in Los Angeles and plan to retire to Dallas within the next few years, a California property collapse could really sting. Should you sell your Los Angeles home now and rent until you move? It could be a smart strategy. But it could also be a lot of hassle.

• Mortgaging your future. It isn't just skyrocketing home prices that have people worried. There's also been much hand-wringing over ballooning mortgage debt. But if you have a hefty mortgage, it won't necessarily hurt you during a market decline.

Imagine that you and the elderly couple next door both own $300,000 homes. They are debt-free, but you still owe $240,000 to the bank. If the price of both homes declines to $240,000, your home equity would be wiped out. But your $60,000 loss is no larger than your neighbors'.

In fact, the elderly couple may have suffered more. Many think the biggest threat to the housing market is higher interest rates, which would hurt demand by making mortgages more costly.

Under that scenario, your elderly neighbors might suffer a double whammy, with the value of their home and their bond portfolio getting battered. By contrast, you probably don't own a whole lot of bonds. Instead, you are a big-time borrower, thanks to your mortgage. As Mayer notes, that mortgage is now more valuable because you have a loan with a below-market rate.

This assumes you have a fixed-rate mortgage. What if you have an adjustable-rate loan? Higher interest rates would mean bigger mortgage payments. But the news might not be all bad: If the increase in rates were driven by rising inflation, you might find your income rising, too — and thus the larger monthly payments would be entirely manageable.

• Next time around. The above scenario isn't quite that rosy. If falling prices wipe out your equity, you might be fine if you stay put. What if you need to move?

You might be trading one depressed property for another, but you'd still need a down payment that you wouldn't get from selling your house. In fact, once you figure in the brokerage commission to sell, you might be underwater.

To ensure that you have plenty of home equity when you sell, you could pay down your mortgage more quickly by making extra principal payments. You could also save the extra money for a down payment.