Buying in a Rocky Housing Market

The apartment, listed at $519,000, was theirs for only $480,000 — an initial offer they didn't back down from, even though they knew the seller had bought the place 10 months earlier for $512,000. Factoring in the broker's fee and sales taxes, the seller lost more than $44,000 on that deal, according to the couple's realtor, Jay Michael, owner of the Estate Property Group in Chicago.

"We leveraged the fact that they'd already moved out and were in a [financial] struggle to keep two places," Klauer says. And even though the condo's value may drop further, the couple wasn't concerned since they plan to live in the place for at least three to five years. "It was a good time to buy," he notes. "Prices are on the down low, and it's something I could sit on for a while."

Watching housing prices plummet is just the push opportunists like Klauer need to jump in and snatch up a bargain on a prime piece of property — one that just a little over a year ago was unreasonably overpriced. But, in this market, such deals don't come without pitfalls from tighter lending standards to widespread expectations that home values will continue to fall as foreclosed properties glut the market.

Home prices declined 8.9% in the fourth quarter of 2007, compared with the same period in 2006 — the largest drop in 20 years, according to the S&P/Case-Shiller U.S. National Home Price Index, which tracks housing data. Many markets posted double-digit drops, including Miami, where home prices fell 17.5%, and Las Vegas and Phoenix, down 15.3%. (If that isn't daunting enough, consider that during the 1990-91 recession, decline rates bottomed at 2.8%.)

Even though demand for homes and construction may start improving as soon as the second half of this year, Celia Chen, director of housing economics at Moody's Economy.com, projects that the housing market won't completely hit bottom until mid-2009, largely because the glut of unsold homes created by foreclosures will continue to depress prices.

It doesn't help that interest rates, which in late January fell below the 6% threshold for mortgages of $417,000 or less, are as stable as a teenager's mood swings. For the week ending Feb. 29, rates were up to 6.3%, according to market research firm HSH Associates. Rates on jumbo loans, or those of $417,000 or more, remain high, at an average 7.18%. Fannie Mae and Freddie Mac recently upped the jumbo loan limits in some of the most expensive housing markets to $729,750. "It's a very unsettled marketplace," says Keith Gumbinger, vice president of HSH Associates. "Rates are high for a couple of weeks and then go back down, as investors are running up and down the seesaw on inflation and recession."

It's no wonder that most buyers are staying on the sidelines. In January, existing-home sales declined by 23.4% from the prior year, according to the National Association of Realtors. New-home sales also sank to their lowest point since early 1995.

"People are waiting for the other shoe to drop," explains Jonathan Miller, president of Miller Samuel, a New York-based real estate appraiser. "You could even argue that there are lots of people who want to buy, but they don't want to look stupid."

Yet, with so many properties to choose from and desperate sellers willing to negotiate, it may still be tempting to buy a home in this tumultuous market. Here are three things you should know before you start house hunting.

"The break line of good to bad credit used to be a FICO [score] of 620," he explains. "Over the last year, it's moved to 650, then 680 and now it's starting to push over 700." Borrowers who have lower scores may have to come up with higher down payments, or settle for loans with higher fees or interest rates.