The year 2004 was another good one for home sales. At the beginning of 2004, interest rates on 30-year fixed-rate mortgages were expected to rise to 7.5 percent by the end of the year. But in early November, interest rates were still well under 6 percent. Low rates kept housing relatively affordable, even as home prices continued to rise in many areas

The market forces of supply and demand determine whether the market favors sellers or buyers. When the supply of homes for sale rises, buyer demand becomes diluted. Buyers have more to choose from, so the sense of urgency to buy now tends to wane.

In a market with a limited supply of homes for sale, sellers often have the upper hand. Buyers find themselves in multiple offer competition, which puts an upward pressure on home prices.

Interest rates serve as the lubricant that keeps the wheels churning. High rates can squelch demand, which was the case in the early 1980s. Few buyers could qualify when interest rates hovered near 18 percent. Recently, low interest rates have propelled the home sale market forward.

Looked at from a national perspective, it would appear that the ingredients are in place for the continuation of a seller’s market. However, generalizations that apply to a larger market, may not apply to the home sale market in your neighborhood. If you’re trying to determine if this is a good time for you to buy or sell, your analysis should focus on your local scene.

For example, the Los Angeles home sale market was booming through the summer months. Recently, the inventory of homes for sale increased and that market slowed down. Exactly how much the market has slowed is difficult to measure accurately because a certain percentage of those homes listed for sale are overpriced for the market. This often happens when sellers rush to sell in time to take advantage of a spike in home prices. Even when the inventory of homes for sale is low, there’s rarely a demand for overpriced listings.

Focusing on the local level geographically may not give you the full picture. Within one neighborhood, you may find that there are different market forces at work, depending on the price range. For example, in the San Francisco Bay Area, you tend to find that homes priced below $500,000 are still selling quickly, many with multiple offers

The same dynamic does not apply to the million-dollar-plus market, where there are fewer buyers and fewer multiple offers. In fact many of the higher-priced listings are taking months to sell. Keep this in mind if you’re planning a trade move.

House hunting tip: Now is a good time for repeat home buyers to make a move because interest rates are low. If you’re selling a lower-priced home in order to buy in a higher-priced home, you could find that you’re selling in a seller’s market and buying in a buyer’s market. However, if you’re selling a more expensive home, you may experience a slower market than you might have expected. This should be factored in to your decision to buy or sell first.

The closing: Anecdotal evidence suggests that in some areas the home sale market is in a transitional phase from a seller’s market to a more balanced market. Buyers are more discriminating. Homes with an incurable defect like a location near a busy freeway or up a lot of stairs aren’t being snapped up. Overpriced listings aren’t moving. However, where inventories remain low, well-priced listings continue to be in demand.

Fed Chairman Alan Greenspan has assured us there is no housing bubble. Consumers aren’t taking on unaffordable mortgages, lenders aren’t being imprudent, there’s nothing to see here, folks – move along now.

Forgive me if I’m not so sanguine.

I will concede Greenspan’s point that a nationwide decline in home prices is unlikely. In the United States, we haven’t experienced such a coast-to-coast phenomenon since the Great Depression.

But I see bubbly local markets all over the country, particularly on the coasts. And the loose lending practices that helped lead to real estate recessions in the past can’t hold a candle to the free-for-all we’re experiencing now.

Some markets riskier than ever
There’s been a huge rise in subprime, zero-down and interest-only loans in recent years. People who would have been laughed out of the bank a couple of decades ago because of poor credit or lack of a down payment are now eagerly sought after, while those with more solid finances are urged to stretch further and further to buy ever more lavish homes.

All this could be putting some real estate markets more at risk than they’ve ever been.

Consider:
Nearly 9% of the mortgages made last year were subprime, or made to people with troubled credit or uncertain finances. That’s up from 4.5% in 1994. In terms of volume, $388 billion in subprime-mortgage loans were originated in the first nine months of this year – more than triple the amount made eight years ago, according to Inside Mortgage Finance Publications, a Bethesda, Md., company that provides news and statistics to the residential-lending industry.

Zero-down loans totaled more than $80 billion last year. They were virtually nonexistent a decade ago. Another relatively recent phenomenon is the 125% loan. It allows people to borrow more than their homes are worth.

More than one-third of mortgage applications in recent weeks have been for adjustable, rather than fixed-rate, mortgages. ARMs expose consumers to more risk, because their payments can rise along with interest rates.

Interest-only loans were, until five years ago, almost exclusively a product for the wealthy, who had plenty of real estate exposure in their portfolio. Now they’re being pushed as a viable alternative for the average Joe – who is probably underestimating the potential risk he’s taking on. (For more details, see “Can you handle an interest-only loan?”) Interest-only loans now make up 25% of all the loans that are securitized, or sold to investors, and are even being pushed in the subprime market.

Borrowing trouble
These trends worry some regulators and mortgage analysts, who fear that the loans are enticing some borrowers to buy more home than they can really afford. Folks with adjustable and interest-only mortgages are particularly vulnerable: When a homeowner is already stretching to pay the mortgage and the payment isn’t fixed, it doesn’t take much of an interest-rate bump to make that loan unaffordable.

“There’s a lot of concern that . . . these loans are going to go bad,” said Andrew Analore, editor of Inside B&C Lending, an Inside Mortgage Finance publication.

And higher interest rates are all but certain. Not only is the Fed raising short-term rates, but a ballooning federal deficit is starting to make bond investors nervous, which could drive up longer-term rates over time.

Faced with higher payments, homeowners who have drained all the equity in their home or who didn’t put anything down to begin with are much more likely to simply walk away. The same is true for those with troubled credit. (The serious delinquency rate, where borrowers are 90 days overdue or in foreclosure, is 1 in 12 for the subprime market, versus about 1 in 100 for the prime.)

Which cities are most vulnerable?
A spiking foreclosure rate can set off a vicious cycle in vulnerable markets. Lenders don’t want to hang on to foreclosed homes, so they slash the price for quick sales. That depresses the value of surrounding homes, which can wipe out the equity of other, overextended borrowers, who now become more likely to hand over their keys to the bank, which leads to another round of fire sales and depressed values.

Lenders – and investors who buy mortgages – get more cautious, as well, once they’ve been burned. The easy money starts to dry up and appraisals get more cautious, making it harder to get deals done. Potential homebuyers start to delay their purchases, waiting for prices to fall further, which helps fuel the decline.

This was the cycle that helped drive home prices down more than 20% in Southern California in the early- to mid-1990s and delivered similar blows to Boston, Dallas, Houston and Anchorage in the mid- to late-1980s. All these markets had experienced phenomenal price increases before the helium started to escape.

Predicting which cities are most vulnerable now, though, is tricky. In the past, bubbles have continued as long as the local economies remained strong and populations rose. It took a strong economic shock, such as sharply lower oil prices for Texas or rapid downsizing of the defense industry for California, to really pop the balloon.

Cities that have experienced only modest price appreciation are almost certainly less vulnerable to these kinds of crashes. It’s unlikely that Peoria, Ill., or Sheboygan, Wis., where markets have appreciated about 20% in the past five years, could stumble as hard as San Diego, where home prices spiked that much in 12 months. (If you want to see how your city has appreciated, visit the Office of Federal Housing Enterprise Oversight’s House Price Index.)

Living in a bubble? 4 tips
So what should you do if you suspect you’re living in a bubble? Here’s my advice:
Don’t try to time the market. Prices may crash, or they may not. Even if you truly are living in a bubble market, remember that bubbles can persist for a very long time. People who delay home purchases waiting for prices to drop could be waiting for years – and perhaps forever.

Buy only if you can stay put. In normal markets, it can take three to five years for home prices to appreciate enough to offset the costs of buying and selling. If the market really tanks, it can take a decade or longer.

Boost your equity, if you can. A bigger down payment when you buy, and extra mortgage principal payments afterward, can help you build a financial cushion. If worse comes to worst, prices drop and you lose your job, at least you’ll be able to sell your home for more than the mortgage rather than suffer a foreclosure, which will devastate your credit. (Before you make extra mortgage payments, though, make sure the rest of your finances are in good shape: that you’ve paid off your credit cards and other debt, established an emergency fund and contributed to your retirement funds.)

Consider downsizing now, if that was already in your plans. On the other hand, if you intend to move to a cheaper area or house in the next few years, it may be smart to pull up stakes now. Sure, you may forgo a bit more appreciation, maybe even a lot more. But you’ll have locked in your profits.

Points versus rate
You can trade fewer or no points for a higher rate to avoid high closing costs.
Document preparation fee
Most documents are on computer. Ask for a waiver.
Processing fee
Get this paperwork handling fee waived and save up to $150.
Underwriting fee
This fee runs $150 to $300. Negotiate the lowest amount for an uncomplicated loan.
Warehouse fee
This fee can run about $200. Ask for a waiver.
Appraisal review fee
You should only be charged if you request a formal review.
Notary fees
If the lender has an in-house notary, ask for a waiver.
Courier fees
You may pay $50 just to courier your paperwork from the lender to the settlement agent. Deliver the documents yourself.
Settlement, closing or escrow fee
This can reach $1,000. Negotiate with the seller to split the cost

Applying for a mortgage can be a daunting experience.

It’s not enough that you’re agreeing to take on the biggest debt of your life, one that represents two to three times your annual income. You’re also confronted with piles of paperwork, flurries of fees and a tidal wave of terms, from amortization to title insurance, whose meaning is fuzzy at best.

“Whether it’s a professor at Stanford or a ditch digger,” said San Francisco mortgage broker Leon Huntting, “most people don’t understand the loan process.”

In this confusing and pressure-filled atmosphere, it’s easy to make some mistakes. Here are some common ones that lenders and mortgage brokers see, and what you can do to prevent them.

Not fixing your credit
Mortgage brokers say they’re confounded at the number of buyers who apply for a mortgage with their fingers crossed, hoping their credit will allow them to qualify for a loan.

Before you even think about applying for a mortgage, obtain copies of your credit report and your FICO credit score. Your FICO score is the three-digit number that’s used in 75% of mortgage-lending decisions. You can order your FICO score on the Web for a fee of $12.95, which includes a copy of your credit report. (See link at left.)

Doing this at least six months in advance should give you plenty of time to challenge any errors on your report and ensure that they’re removed by the time you’re ready to apply for a loan. You can also see the legitimate factors that are hurting your score and do something about them, such as paying off an overdue bill or paying down credit card debt.

Not looking for first-time home buyers’ programs
These programs, typically sponsored by state, county or city governments, often offer better interest rates and terms than you’ll find among private lenders, said mortgage consultant Diane St. James. Some are tailored for people with damaged credit, while most can help people with little saved for a down payment.

Some of these resources are listed on St. James’ educational Web site, ABC Mortgage Consulting (see link at left). You can also call the housing agencies for your state, county and city to see what they offer.

Not getting pre-approved for a loan
Many first-time borrowers confuse being “pre-qualified” with being “pre-approved.” Pre-qualification is a pretty casual process, where a lender tells you how much money you probably can borrow based on how much money you make, how much debt you already have and how much cash you have for the down payment.

Getting pre-approval, by contrast, is a much more rigorous process and involves actually applying for a loan. You typically submit tax returns, pay stubs and other information. The lender verifies the information and checks your credit. If all goes well, the lender agrees in writing to make the loan.

In a hot or even warm real estate market, the house hunter who is only pre-qualified is a cooked goose. Home sellers and their agents give much more weight to offers being made by buyers who already have a loan lined up.

Borrowing too much money
Many people take out the biggest loan they possibly can, figuring that their incomes will eventually increase enough to make the payments comfortable. But few first-time buyers have any clear idea of how expensive homeownership can be. Not only will you shell out more for mortgage payments than you probably did for rent, but you’ll also need to cover property taxes and homeowners insurance, as well as higher bills for utilities, maintenance and repairs than you faced as a renter.

Lenders are perfectly willing to let you overextend, knowing that you’ll probably forgo vacations, retirement savings and new clothes for the kids rather than default on your mortgage.

“Mortgage money … is way too easy to get,” said Ted Grose, president of the California Association of Mortgage Brokers. “People tend to overbuy … and that can really stress family life. It’s also a formula for foreclosure.”

Instead of going to the edge of affordability, consider limiting your housing costs – mortgage payments, property taxes and homeowners insurance – to 25% or so of your gross income. That’s a much more sustainable level for most people, financial planners say, than the 33% lenders are typically willing to give you.

Not shopping around for rates and terms
Mortgage broker Allen Jackson of Bristol Home Loans in Bellflower, Calif., sees too many borrowers with decent credit getting stuck with loans meant for people with poor credit. So-called “subprime” loans are often more profitable, so less ethical mortgage brokers may push them.

If the borrower doesn’t know what the prevailing interest rates are for someone with their credit standing, Jackson said, they can easily pay thousands of dollars more than they need to. You can see a listing of loan rates by credit score at MyFico.com, and a comprehensive listing of prevailing rates and fees can be found in MSN Money’s Banking area.

Even people with a few dings on their credit can often qualify for better loans than they’re typically offered, said Grose of 1st Mortgage Advisors in Los Angeles. He believes most of the people being shunted into government loan programs, such as Federal Housing Administration (FHA) loans, would pay less if they used mortgages now being offered by private-sector lenders.

Paying junk fees
Lenders can boost their profits by adding on a variety of fees. Some may be legitimate, some may be inflated and others may be pure fluff. Lenders may charge for “document preparation,” for example, when all that involves typically is having a computer spit out a form. Or they may charge $150 for a credit check that cost them $15.

The time to challenge junk fees is not when you’re about to sign the loan papers. Use a mortgage broker or call a number of lenders to compare their loans. Ask about the interest rate, the “points” charged to get that rate (each point is 1% of the total loan amount) and any other fees the lender charges. Then you can compare terms.

Once you’ve selected a lender, you’ll be given a good-faith estimate of closing costs, which should include any fees being charged. Ask about each fee, and try to negotiate down the ones that seem excessive.

If the lender won’t negotiate, “take that estimate to someone else,” St. James said. “I’ll bet they can beat it.”

Unfortunately, this doesn’t absolutely guarantee you won’t face junk fees when it comes time to sign the loan. Many borrowers complain that they still face higher costs than were originally estimated, and so far the federal government has done little to prevent the practice. You can try challenging junk fees at this point, but most likely you’ll have to bite the bullet and pay the fees to get your loan.

Not planning for closing costs
The day you’re scheduled to get your loan, known as closing, you’ll also be expected to write a check for a number of expenses, which typically include attorney’s fees, taxes, title insurance, prepaid homeowners insurance, points and other lenders’ fees. Together, these are known as closing costs, and the total can be eye-popping: somewhere between 2% to 7% of the selling price of the house.

“Usually, when people see the closing costs, they’re like a deer in the headlights,” said mortgage broker Huntting, who works for Pacific Guarantee Mortgage. “It’s much more than they ever think it’s going to be.”

Plan for closing costs by getting a good-faith estimate from your lender as early in the loan process as possible. Make sure you have the cash on hand (or rather, in your checking account) and that it doesn’t “disappear” before closing because of sloppy bookkeeping or a last-minute emergency.

Not having enough cash on hand after closing
After borrowing too much, and scraping together every last dime for closing costs, many home buyers have nothing left in the bank to pay for anything unforeseen happening –and something unforeseen always happens.

“It costs so much just to move in,” Grose said. “Then the water heater breaks.”

Some people are so tapped out by the process, Jackson said, that they’re not able to make their first mortgage payment on time. That’s why “more and more lenders are requiring [borrowers have] three months’ reserves after closing,” Jackson said.

That’s a smart idea for borrowers, anyway. Having three months’ reserves, which means a fund equal to three months’ worth of expenses, will help you handle the added costs of homeownership with much less stress

group of Arizona homeowners has filed a lawsuit against KB Home, charging that the home builder engaged in fraud by failing to properly disclose a history of crop-dusting operations at a development site and failing to properly notify home buyers about a special tax district.

A KB Home spokeswoman said company officials “are disappointed that these homeowners have chosen litigation,” and that the company “is diligent in creating our disclosures and in communicating with our homeowners.”

Thomas A. Stoops and Michael T. Denious, lawyers at the Stoops, Denious & Wilson law firm in Phoenix, Ariz., filed the lawsuit with the Arizona Superior Court in Pinal County. The lawyers are representing a group of homeowners that includes 12 married couples and three individuals. Stoops and Denious offered no comment on the lawsuit

The lawsuit alleges that KB had failed to disclose that parts of a subdivision in the Phoenix area, known as SK Ranch, and adjacent property was formerly the Three Point Airport, which was used as a base for “aerial applicators of agricultural pesticide and herbicide from 1940 to 1984.” All of the home buyers represented in the lawsuit entered into contracts to purchase homes at SK Ranch.

The lawsuit also states that KB Home failed to properly disclose plans for a special tax district at SK Ranch that raises money from homeowners for various improvements.

Homeowners represented in the lawsuit are seeking a rescission of the purchase of their homes or compensatory damages, and punitive damages and lawyer fees.

This is not the first time that questions have been raised about proper disclosures at the development site. The Arizona Department of Real Estate last year issued a consent order against KB Home that found KB violated real estate subdivision laws “by failing to disclose to some purchasers the existence of a special assessment district.”

The department and KB negotiated a settlement agreement that included civil penalties and payments of about $43,000 and “reimbursements to certain purchasers for the undisclosed special assessment district,” according to a July announcement by the department. Eight home buyers reportedly did not receive a notice of the special tax district before closing on their home purchase.

Also, the department “maintained throughout the course of its investigation that KB Home failed to adequately disclose the existence of the Three Point Airport” in its application for a subdivision public report. And “although KB Home agreed to amend their public report to include the disclosure of the Three Point Airport, they declined to admit to any wrongdoing specifically pertaining to the airport,” according to the department’s announcement.

Also, in its June 23 consent order relating to KB Home, the department “denied KB Home’s application for renewal of its real estate license,” though “KB Home appealed the denial and was granted renewal of its license.”

Kate Mulhearn, a KB Home spokeswoman, said of the state’s order, “It is important to note that KB Home was not found to be in violation regarding timely disclosure of the existence of Three Points Airport.”

She said that based on the prior uses of the SK Ranch property, “We hired third-party experts to test the soil specifically for pesticides before purchasing the land or building homes,” and those experts “concluded that the site was completely clean and appropriate for new homes.”

Mulhearn said KB offered the homeowners a “mediation process to address their concerns, but our offer was rejected.” There are 281 homes at SK Ranch, and Mulhearn said most of the site is built out with only a couple of model homes still available.

The lawsuit alleges that the homeowners represented in the lawsuit entered into contracts with KB from late 2000 through 2002, and KB Home in mid-2003 “amended its public report for SK Ranch to disclose the Three Point Airport and the aerial application of pesticides from the airport.”

The suit alleges that KB Home engaged in a “pattern of unlawful activity” relating to “intentional or reckless false statements or publications concerning land for sale.”

Mulhearn said that in response to requests by the Arizona Department of Real Estate, KB Home provided each SK Ranch homeowner with information on where they can view environmental impact reports prepared for KB Home on SK Ranch.

As a part of the consent order, KB was required to work with colleagues and the state department “to help establish means and methods for ensuring responsible industry compliance with disclosure requirements, and the department’s enforcement of those requirements,” according to a report by the state department.

Mulhearn said KB Home “has industry-leading disclosure practices. Nonetheless, we constantly strive to improve our processes to make sure that (we) do not encounter the type of regulatory and consumer concerns we experienced in SK Ranch.”

The lawsuit names KB Home Sales-Phoenix, KB Home Phoenix, KB Home, and Kaufman & Broad Home Sales of Arizona, as defendants.

Those who fear that we’re in a fragile real estate bubble can relax – for now. All the economic cards but one point to another strapping year for housing prices.

One good thing you can say about the pundits who keep predicting that the end is near for rising home prices: They’re consistent. They’ve been dead wrong year after year.

Despite their near-certainty that the market would cool in 2004, median U.S. home prices rose 9%, and a vast majority of cities saw a bigger increase than in 2003. In fact, the National Association of Realtors proclaimed 2004 the hottest U.S. home-sales market in history. Says Thomas Kunz, CEO of Century 21 Real Estate: “There’s been no rhyme or reason to prices because of multiple offers and bidding wars.”

And those who fear that we’re in a fragile real-estate bubble can relax – at least for now. David Seiders, chief economist for the National Association of Home Builders, speaks for most chastened housing-market analysts when he says that the chance that median home prices will drop is “zero nationally, zero in major regions and close to zero in any state,” although some individual cities may see declines.

All the economic cards but one point to another strapping year for housing prices

Demand for new homes continues to be strong, driven by both first-time home buyers and people like Melani and Coates Lear, who are trading up from their Denver bungalow to a built-to-order house in a suburban development. In addition, a stronger economy, a stronger job market and higher incomes are the positives, says Seiders. He predicts the only moderating force will be modestly higher interest rates. (By “modestly higher,” he means a rise from the current 5.8% to 7% for a 30-year fixed-rate mortgage.)

Most housing-market analysts now say they expect the median price increase to cool to the 5%-to-6% range nationally in 2005. Then again, that’s the range they predicted for 2004. A cooling-off would also mean that houses stay on the market longer before they’re sold, giving buyers more negotiating leverage.

Despite what you might think about soaring prices in your neighborhood – or the neighborhood you’d like to live in – investment strategist Ed Yardeni of Oak Associates says home prices aren’t outrageous given the low interest rates. “You’d find out if this is a bubble if mortgage rates rose two, three or four percentage points.” He predicts that would result in a loud pop, followed by falling prices. But Yardeni doesn’t foresee such a hike in rates, and expects single-digit percentage increases in prices for the next three or four years.

Population boom
The demand that’s driving the U.S. housing market comes from many sources. The country’s population is increasing by about three million people – or a million households – annually, according to John McIlwain, of the Urban Land Institute. And it’s no surprise that most of the growth is on the coasts, in so-called gateway cities that see high rates of immigration, global trade and direct foreign investment (Chicago is also considered a gateway). Not coincidentally, gateway cities have also seen some of the biggest increases in home prices.

Other demographic trends are fueling this demand. Minorities, especially Hispanics, are buying in record numbers. The echo-boomer generation – born between 1977 and 1994 and 72 million strong – is beginning to enter the home-buying market. And don’t dismiss their baby-boomer parents. Coldwell Banker Real Estate CEO Jim Gillespie points out that the youngest baby-boomers, in their early 40s, are buying up, and the oldest, nearing 60, are in their prime earning years and also buying up or buying second homes.

Meanwhile, on the supply side, developers and builders in the nation’s hottest markets are hemmed in on one side by an ocean and on the other by the high cost of land and by land-use constraints. David Lereah, chief economist for the National Association of Realtors, says that builders still haven’t loosened up since being burned by the real-estate recession of 1990-91.

About one-fourth of the nation’s 316 largest metropolitan areas enjoyed double-digit price appreciation in 2004, with most in California, Nevada, the Northeast Corridor (traditionally from Washington, D.C., to Boston, but now stretching to Portland, Maine) and Florida. Except for Honolulu, nine of the ten cities with the highest median home prices are in northern or southern California. San Francisco, arguably the hottest housing market over the past decade, has the highest median price ($629,005).

(Visit Kiplinger’s online database of more than 300 cities to see how home prices in your city have fared over the past one, three and five years.)

Trade-offs
As many buyers, especially first-timers, continue to be forced to the far suburbs, at least they’re no longer sentenced to cookie-cutter gulags. Case in point: The Lears of Denver loved their urban lifestyle and their first home, a 1907 bungalow in central Denver. But when son Dawson arrived in August, the couple figured that their perfect little house would soon feel, well, little. Moving to a larger home in their current neighborhood, where a house big enough for a family of four runs $600,000 to $700,000, wasn’t an option.

Resigned to looking in the ‘burbs, the Lears cast their eyes east to Stapleton, five miles from downtown Denver, where the former Denver International Airport is being turned into the country’s biggest planned community. Such developments are among the major trends shaping home building today. The couple has committed to a 2,000-square-foot home, with a base price of $360,000, that will be finished by the end of this summer.

Anticipation has replaced resignation. “Stapleton offers a lot of things that we liked about living in the city,” says Coates, 35. A neighborhood park and pool within several blocks of their house are planned. A town center will feature restaurants and service providers, such as drugstores and dry cleaners. Best of all, the community has lots of other young families, with “strollers everywhere,” says Melani, 31.

The best developers and builders now provide homes with a sense of place and community because that’s what sells. Prairie Crossing, 40 miles northwest of Chicago, is another good example. Built on a former farm, with homes tightly clustered to preserve open space, the community is served by two commuter-rail lines into Chicago.

Gary Mitchiner, 48, and his wife, Ellen Winick, 43, moved to Prairie Crossing in 1996, having previously lived in downtown Chicago. They say the community is an ideal place to raise their two children. “We have more house and more community for the money in Prairie Crossing. It’s a joy to wake up every morning and look out at 100 acres of open land,” says Gary.

Still, heaven to some is boondocks hell to others. So a second major trend in home building is driving builders to scour the inner suburbs and downtown for land and properties that can be developed or redeveloped for residential use. Homes in these areas are typically pricey because land and development costs exceed those of green-field development farther out.

In Seattle, the Cottage Company builds “pocket neighborhoods,” which consist of bungalow-style houses of less than 1,000 square feet built around a common garden. Partner Linda Pruitt says that their homes, which are typically priced in the high $300s, mainly attract single people and couples who sacrifice a large lot (and tons of yard work) for smaller, newer, high-quality homes.

Downtowns in Atlanta, San Diego, Kansas City and Milwaukee are returning to life as young professionals and empty-nesters move back for the urban scene. Nationwide, the condos and co-op apartments going up are roomy, loftlike spaces that are pricey and loaded with amenities. Condos set a new sales record in 2004 – 1 million sold, versus 898,000 in 2003 – and the median condo price hit $197,000. That’s an 18% increase over the year before.

Sun Je Gray, 29, and her husband Dennis, 34, moved to Kansas City’s River Market neighborhood two years ago with the idea of “being close by to things,” such as the bustling farmers market, to which they can walk. Their loft-style apartment, which cost $270,000, has just under 1,500 square feet and a 300-square-foot balcony that has views of the Missouri River and the city. “If we have a child, we would probably want a house with a back yard,” says Sun Je. “But that’s in the future.”

Home prices on coasts up the most
Cities on the West and East coasts continued to rack up the biggest price gains in 2004. And the high prices along the coasts are pushing development inward, expanding California’s Inland Empire and pushing up prices there, according to data prepared for Kiplinger’s by consulting firm Global Insight.

In Sacramento, for example, median home prices rose 17%, and both the Riverside-San Bernardino area and Fresno saw 23% increases. A similar, though less extreme, trend is happening on the East Coast, as prices rise in places such as Glens Falls, N.Y. (10%), Albany-Schenectady, N.Y. (11%), and Allentown, Pa. (10%).

Las Vegas – a.k.a. “the state of Las Vegas” – posted gains in home values of 23%, up from 9% in 2003. Described as “the bulldozer convention of the world,” the city is expected to lead the nation in new-home construction starting in 2005. Phoenix led the Southwest (excluding Vegas), with a 17% rise.

Growth in Georgia continues at a blistering pace, with 20 of the 100 fastest-growing counties, based on housing starts, according to the U.S. Census Bureau. For the past 13 years, Atlanta has led homebuilding in the U.S., according to the National Association of Home Builders, and the city remains affordable, with a median home price of $166,222 and price appreciation of just 4.4% in 2004.

Although experts expected prices in many Florida cities to cool in 2004, Fort Lauderdale and West Palm Beach ignored the prognosticators and rose 18% and 19%, respectively

DEAR BOB: My townhouse is worth about $300,000. My mortgage balance is around $46,000. I believe I can buy a small house for under $200,000 in Arizona. Does it make sense to buy the new house with no mortgage? What if I find that house before I sell my current home? – Judith E.

DEAR JUDITH: If you commit to buying a $200,000 house in Arizona for all-cash before selling your current home, you might be in financial hot water unless you have $200,000 spare cash.

Instead, I suggest you include a mortgage contingency clause in your purchase offer for a 75 percent or 80 percent mortgage just in case your townhouse doesn’t sell as quickly as you anticipate and for as much money.

More important, I recommend you don’t commit to paying all-cash for a home in a new area where you are not currently living. It just isn’t smart to put all your eggs in one basket, especially if you are unfamiliar with the community.

Maybe you won’t like the famous Arizona “dry heat” summers. Worse, suppose the zero-mortgage home you buy has lots of unexpected defects, but most of your nestegg is tied up in that “lemon house.”

However, after you have lived in your Arizona house for a few years and all is well, then paying off your mortgage would be a smart idea to save interest. For this reason, be sure the mortgage you obtain does not have a prepayment penalty.

HOW PRE-1997 DEPRECIATION GETS TAXED

DEAR BOB: In a recent article you said rental property depreciation deducted by an investor after May 6, 1997, is taxed upon property sale at a special federal depreciation recapture tax rate of 25 percent. My question is what happens to the depreciation I deducted before May 6, 1997? Is it taxed? I bought my rental property in June 1975 and sold it in August 2000 – Manuel DeL.

DEAR MANUEL: Hopefully you reported the property sale correctly on your 2000 income tax returns because the three years to amend your tax returns has elapsed.

Depreciation you deducted before May 6, 1997 (when the 1997 Tax Act became effective) is taxed as part of your capital gain sale profit.

If you sold your investment property today, this “old depreciation” would be taxed at a maximum 15 percent federal tax rate for capital gains. Only the depreciation deduction after May 6, 1997, is “recaptured” and taxed at the special 25 percent federal “recapture” capital gains tax rate.

The only way to avoid this higher “recapture” tax is to die while owning your rental property. Death is the ultimate tax shelter of all. For full details, please consult your tax adviser.

SORRY, NO TAX-DEFERRED EXCHANGES FOR R.E.I.T. STOCK

DEAR BOB: My husband and I want to sell our single-family rental house. But the federal and state taxes will be enormous since we’ve owned the house over 30 years. Would it be possible to “exchange” the property for shares in a mutual fund REIT (real estate investment trust)? Our accountant says it can be done, but through a special arrangement called a “CIT.” Do you agree? – Alice G.

DEAR ALICE: I regret to inform you that it is not possible to make an Internal Revenue Code 1031 tax-deferred exchange of your rental house for REIT stock. The reason is that is an “unlike kind” trade of real property for personal property.

I have no clue what a CIT is so I can’t comment on that alternative.

However, you can made a Starker delayed tax-deferred IRC 1031(a)(3) exchange of your rental house for a TIC (tenancy in common) interest in a qualified investment property.

For example, about 10 years ago my retired friends Andy and Dory sold their California rental house and made a Starker tax-deferred exchange for a TIC interest in an Applebee’s Restaurant in Kentucky. Every month they receive a nice check for their profit share. Needless to say, they are very happy.

Nearly every time I run someone’s credit, I get asked questions like “will running my credit HURT my credit score?” or “how can I fix my credit?”

Your credit score is the single biggest factor in getting a new home loan. If your score is above 720, you can possibly qualify for a $1 million home with very little money down. If your score is below 500 and you have $1 million in the bank, you may have trouble qualifying for this exact same home. Your interest rate will certainly be different.

Credit scores are central to the loan process. Nearly every lender uses them. The better your credit, the lower the risk to the bank, the lower your interest rate.

Most lenders use your FICO score to determine whether or not you qualify for a home. It’s such an important issue that you and your clients should understand the basics of the credit reporting system and the many myths surrounding it.

Credit scores give lenders a fast, objective and impartial snapshot of a person’s credit risk based on their credit history.

That’s why lenders use FICO credit scores when making credit decisions. The higher the individual’s score, the lower the risk to lenders when extending new credit to that person. Its fast, easy, and, usually, effective.

ABOUT YOUR FICO SCORE
Think about your credit report as a story about your financial life, as told through your credit history. This has nothing to do with you personally. Everything is there from the first credit card you got out of high school to your cell phones to your most recent mortgage. It all has a very telling payment history. Some of it is good and some of it maybe not-so-good. Regardless, it tells a lender what he needs to know about you. It tells the lender how committed you have been, historically, to paying your bills, both big and small, on time.

It simply tells us how risky it is to loan you money.

A FICO score is a credit score developed by Fair Isaac & Co. Credit scoring. It is a method of determining the likelihood that credit users will pay their bills. It helps lenders determine the “risk” in granting you a loan.

This method has become widely accepted by lenders as a reliable means of credit evaluation. A credit score attempts to condense a borrower’s credit history into a single number. Fair, Isaac & Co. and the credit bureaus do not reveal how these scores are computed and The Federal Trade Commission has ruled this to be acceptable.

Credit scores are calculated by using scoring models and mathematical tables that assign points for different pieces of information which best predict future credit performance. It basically gives us a risk rating today of how likely you are, compared to the rest of the people in the U.S., of paying your bills tomorrow.

Credit scores measure the likelihood of default, so credit scores are generated using factors that have been found to predict credit risk. These factors are not weighted evenly and several minor instances may indicate a higher risk than one major, but isolated, credit problem.

There are five main categories of credit information which impact your credit score:

1. Late payments, delinquencies, bankruptcies: Past inability to pay on time will hurt your chances of getting credit in the future. More recent problems will be counted more heavily than those in the past.
2. Outstanding debt: The more debt one has, the greater the risk that he or she will not be able to keep up with the payments
3. Length of credit history: With a short track record it is harder for a lender to assess creditworthiness
4. New applications for credit (inquiries): Frequent credit checks by lenders may indicate that a borrower is looking to increase his or her amount of debt.
5. Types of credit in use: Some types of credit, including credit cards, provide you with a credit line greater than the amount you have already borrowed. The more credit available, the greater the risk to the lender since a borrower can easily increase their outstanding debt.

There are really three FICO scores computed by data provided by each of the three major bureaus––Experian, Trans Union and Equifax.

Most lenders use the middle of these three scores. For example, if Experian gave you a 689, Trans Union 704, and Equifax 696, we would throw out the top score (Trans Union 704), throw out the bottom score (Experian 689) and use the middle score of 696 from Equifax.

Your FICO score for the purposes of our loan would be 696.

The bureaus don’t all share the same data and thus all have different scores . One bureau may list more accounts for you than another, for example, and the differences (in types of accounts, payment histories, credit limits and balances) will be reflected in the score that bureau computes for you.

Because of those differences, it makes sense to pull and examine your credit reports from all three bureaus before you apply for a mortgage. Fixing errors in all three reports before you shop for a loan is smart. We will discuss how to get a copy of your credit report and how to fix it later in this newsletter.

Here are the most frequently asked questions about credit reports:

WHAT IS A GOOD CREDIT SCORE?

Credit scores generally range from the mid-300’s to a perfect score of 850.

The following will give you a general idea of what your score tells lenders, but remember there are no set rules. Different products and lenders use different guidelines for what is an acceptable score.

Also, there will usually be differences in the scores calculated by each of the three credit bureaus. As stated, lenders will often use the middle of your three scores.

720+ = Excellent credit. You should have no problems as most loan programs will be available to you.
680 - 719 = Good credit. You should have few problems depending on what product you seek.
620 - 679 = Lender has to take a closer look at your file but should be able to qualify you for a loan. Some products may not be available.
570 - 619 = Higher risk; you will not be eligible for the best rates and products. Products will be limited.
Below 570 = Very high risk. Products will be limited and other factors will need to be considered.

The average person in the U.S. has a credit score around 675. As you can see on the list above, the average borrower’s file needs a “closer look” and is not a “slam-dunk.”

HOW DOES MY SCORE AFFECT MY INTEREST RATE?
The better your score, the lower the risk to the lender, the lower your interest rate.

Let’s say that John Doe is buying a new house for $300,000. He is employed, can document his income through his tax returns, and has enough funds verified in the bank to put 20% down on the purchase of his new $300,000 home. He wants a 30-year fixed mortgage.

Below you will find an example of how Mr. Doe’s interest rate may fluctuate based on his credit score.

MID-FICO: INTEREST RATE:
720+ 5.60%
680-719 5.80%
620-679 6.50%
570-619 7.25%
500-569 9.00%+

This is a primary example of why when you ask your lender, “what is the rate today?” the answer is not simple unless they know the credit score and financial profile of the borrower. Rates change based primarily on credit scores, use (owner-occupied vs. investment), income documentation, down payment, and availability of funds.

WHAT FACTORS MAKE UP MY SCORE?

Some of the factors considered in credit scores:

Past problems:
• Delinquency
• Recent or serious derogatory public record or collection
• Past due balances

Limited information:
• Account payment or credit history not long enough
• Lack of recent information on accounts
• Insufficient number of satisfactory accounts
• Date of last credit too recent
• Too few or no recent balances on revolving accounts (e.g. credit cards)

Factors correlated with higher risk:
• Excessive amount owed on accounts
• Proportion of loan balances on installment accounts
• Too many new or existing accounts
• Too many recent credit checks
• Proportion of revolving balances to revolving credit limits is too high (e.g. credit card balance vs. limit)

Factors not considered in credit scores

• Age
• Race
• Gender
• Religion
• National origin
• Receipt of public assistance
• Inquiries made by companies for promotional or account monitoring purposes (credit card companies, where you have accounts, often run your credit to make sure your situation has not dramatically changed)

DOES MY CREDIT SCORE GO DOWN EVERY TIME IT IS CHECKED?

If you do all your shopping around in a short period, and it is focused on just getting a new home loan, then the answer is “no”.

Credit inquiries are a negative factor in determining credit scores. That’s because statistical studies show that multiple inquiries are associated with high risk of default. Distressed borrowers often contact many lenders hoping to find one who will approve them.

Multiple inquiries can also result from applicants shopping for the best deal. The credit bureaus understand this and do not penalize you for it.

Credit scorers usually ignore inquiries, from a same industry, that occur within 30 days of a score date. Suppose I shopped a lender on May 30, for example, and the lender has my credit scored that day. Even if I had shopped 50 other lenders in May and they had all checked my credit, none of those inquiries would affect my credit score on May 30.

Now, if you are also shopping for a new car, a new big screen TV, and applying for new credit cards during this same period, yes, that will create negativity on your credit report.

Remember, this score is assessing the “risk” in giving you a new loan. If you are contacting may different types of lenders for many different products, you are giving the appearance of extending your credit our further and that makes you more risky.

You may also damage your credit if you spread your shopping over many months. Circumstances can cause a consumer to shop, drop out of the market, and return later when conditions are more favorable. You minimize the adverse effect by concentrating each shopping episode to as short a window as possible.

WILL CLOSING SOME OF MY ACCOUNTS HELP MY CREDIT SCORE?

Usually not. Closing accounts will not usually help your credit score, and may actually hurt it.

Too many open accounts can hurt your score. But once you’ve opened the accounts, you’ve done the damage. You can’t repair it by shutting the account, and you may actually make things worse.

The credit score looks at the difference between your available credit and what you’re using. Shut down accounts, and your total available credit shrinks, making your balances loom larger, which typically hurts your score.

The score also tracks the length of your credit history. Shutting older accounts can also make your credit history look younger than it actually is, which can hurt your score.

Rather than closing accounts, pay down your credit card debt. That’s something that actually can and usually will improve your score.

If you must close accounts, transfer the balances from newer accounts to older ones and close the ones you have opened most recently.

HOW OFTEN DOES MY SCORE CHANGE?
Your credit report is continually updated with new information from your creditors.

The FICO score is calculated based on the latest snapshot of information contained in your credit report at the time the score is requested. Your FICO score from a month ago is probably not the same score a lender would get from the consumer reporting agency today. Fluctuations of a few points from month to month are quite common.

IF MY CREDIT REPORT HAS SOMETHING WRONG ON IT, WHAT CAN I DO?

As opposed to most lenders who offer you opinions on this subject, I have done this exercise myself.

The first thing you must do is get a copy of your report. I strongly suggest for the best and quickest response, you get a copy of your report from each of the three major bureaus. The easiest and most effective way is to request this online.

Each of the bureaus will charge you a small fee for your credit report but you will get online access and better response times.

If you want to save time and money, you can visit a website called www.myfico.com. The site is owned by Fair, Isaac and Co. In my opinion, it has the best tools for credit repair. Be sure to purchase their top package, which is $48 at the time of this writing. MyFico.com gives you a copy of all three major bureau reports and also has ready-to-use, simple online tools for credit repair like pre-written letters for dispute.

Here is the contact information for each:

Equifax
P.O. Box 740241
Atlanta, GA 30374
1-800-685-1111
http://www.equifax.com

Experian
P.O. Box 2104
Allen, Texas 75013-2104
1-888-EXPERIAN (1-888-397-3742)
http://www.experian.com

Trans Union
Consumer Disclosure Center
2 Baldwin Place
P.O. Box 1000
Chester, PA 19022
1-800-888-4213
http://www.transunion.com

Once you get your report, review it very carefully. If there is an item on your credit report that you feel is inaccurate, and there likely will be, you should challenge it. Details on how to challenge will be sent you with your credit report. The credit bureau is required to begin investigating the issue within 5 business days. They are held to this action by an Act of Congress and they will move fast.

They will contact the creditor on your behalf. You can also contact the creditor yourself but be prepared to experience complete and utter frustration at its highest level. Do not only contact the creditor. The bureau is absolutely your best bet!

Within about 30 days, you should have an answer to your complaint. If, at that time, the original grantor of credit has not responded to the disputed item, it will be removed from your credit report. However, if the creditor responds and challenges your claims, you may have more work to do.

I am amazed at how many people have never seen their credit report until they actually buy their home. There is rarely enough time in the period between the day you make an offer until the day you close to correct your credit report in such a manner that will make a substantial difference in your score.

Planning ahead can result in cleaning your report, raising your score, and saving you $10,000’s in interest through the years.

I COMPLETELY PAID OFF ALL OF MY DEBT, WHY IS IT STILL ON MY CREDIT REPORT?

A credit report shows your entire credit history, including paid off debts. Judgments and liens will remain in your history for up to 10 years. A bankruptcy may stay on your credit report for 10 years as well. Just because you paid it off, does not mean it did not exist.

Like I stated earlier, if you look at this report as the financial story of your life, this existed and although it is now paid, it tells a story about a time when the debt, for whatever reason, went without being paid.

If you were late on your MasterCard five times in six years, just because you paid it off does not mean it is now a positive reflection on your credit report vs. the negative reflection it was before, which some people automatically assume. It simply shows that you were late at times but then paid it off. Don’t expect a huge increase in your score as a result of this action. Keep in mind, the score is based on your credit history, not just how you are today.

HOW CAN I IMPROVE MY SCORE?

• Pay your bills on time. Late payments and collections can have a serious impact on your score.
• Keep balances low on credit cards. Do not “max-out” your cards. Most experts say keeping your balances below 60% is the most effective. For example, if you have a Visa with a limit of $2000, it is best to keep the balance at $1200 or less.
• Limit your credit accounts to what you really need. Accounts that are no longer needed should be formally cancelled since zero balance accounts can still count against you. However, remember, if you are closing accounts, transfer the balances to the oldest accounts and cancel the newer ones.
• Do not apply for credit frequently. Having a large number of inquiries on your credit report can worsen your score.
• Check that your credit report information is accurate.
• Be conservative in applying for credit and make sure that your credit is only checked when necessary.
• If you have limited credit, obtain additional credit. Not having sufficient credit can negatively impact your score.

HOW LONG DOES IT TAKE TO SEE MY SCORES GO UP?
I have seen pro-active people, who aggressively corrected their reports, raise their scores as much as 50 to 75 points in less than 60 days, but I would not count on that. Your credit score is based on your history and that cannot be corrected overnight. Everyday people tell me “my score is 600 but it will be 700 after I make all of the corrections.”

That is not very likely but it is important that you review your report, correct it, and then, if you really care about keeping it clean, pay your bills on time, don’t over extend yourself and don’t max your cards out.

I know of people who are only a few years out of bankruptcy and have gotten their scores up in the high-600’s. If you stay on top of it, and work at it, no matter where you are today, you can have great credit.

IMPORTANT NOTE:
I think it is important from a sales perspective that you do not let your clients “wait” until their credit is better before making their buying decisions. Credit repair can be lengthy, frustrating, and sometimes, fruitless. If their credit is able to be repaired, they can do this once they are in their new home and then refinance into a much better rate or loan at that time.

For example, I did a loan in May for a man with a mid-score of 598. He put 20% down and settled for the best loan program in his situation. However, he assured me he was making a commitment to repairing his credit and asked me to promise to give him a discount on his refinance when he came back. I agree.

One week ago, less than five months later, he called me and asked me to pull his credit. I did. He now has a 699 mid-score. I am refinancing the loan today at a discount and he is saving $100’s per month with a much superior rate…not to mention he now has much more equity than before.

Credit repair can be done effectively but it should not stop your client from buying a house today if he is credit-capable.

Rates popped up about an eighth of a percent last Monday (T-bonds to 4.32 percent, mortgages to 5.875 percent) in response to more Goldilocks data. Pretty good strength, but no dangerous heat.

Consumer confidence jumped to its highest level in six months, the survey possibly showing an improvement in the job market, and certainly reflecting pleasure at the drop in gasoline prices. The housing market may be beginning to top out, as sales and starts of new homes are way off, but resales of existing homes are still cooking and the apparent weakness may be a seasonal distortion. Christmas retail sales were softer than merchants hoped, but overall probably OK; the traditional season no longer exists, as discounting moves a lot of dollar volume past the holiday, and no one really knows how to evaluate the displacement of sales to Internet retail.

It is our custom at the New Year to recite Peter Drucker’s wisdom: “Nobody can predict the future; the idea is to have a good grasp of the present.”

Looking into some New Years, it has been possible to trifle with the great man’s warning: in the ’80s and early ’90s, you knew that no matter what else, the Fed was going to lean against inflation; in the late ’90s that the boom phase was likely to roll ahead; and in the ’00s that the post-bubble mire would be sticky (and still is).

At other year-ends, change was at hand: in January 1995, it was clear that the Fed’s year-long tightening had concluded; in January 2000 it was just as clear that the Fed’s modest tightening had done disproportionate damage. A month before New Year’s Day 1990 the Berlin Wall came down; in January 1991 we waited for the offensive against Iraq, just as we did in January 2003. In those years of change you could make book that some old, dominant patterns would not continue, even if the new ones were not yet evident.

2005 feels like a year of change, and just as in so many other ones, the Fed and war are the catalysts.

In 2005 we are going to learn the location of a neutral Fed funds rate. The ascent from an emergency, 1 percent low has been a mechanical affair; now it’s make-or-break time. Last fall, most guesses ran to a quarter point per meeting all the way from 2.25 percent Thursday to 3.5 percent, give or take a half. This week PIMCO, which buys more bonds than anybody except Japan, announced in certain language that the Fed would hike one more .25 percent in either February or March, “stopping this cycle at 2.5 percent” until unemployment fell back into the fours. Wow. If so, good for stocks, mortgages and the economy in general. If not, not good for same, and we’ll know before spring.

(One financial wild-swing prediction: don’t worry about the dollar. There are good and persistent reasons for a weird trade picture, and the main reason the dollar is low has been an emergency-easy Fed, now mostly rectified.)

2005 will also be make-or-break in Iraq. We cannot maintain a substantial force in Iraq for more than another year without expanding the army and Marines by two or three hundred thousand troops; the Reserves and Guard cannot be called up past the two-year statutory limit, and regular troops are approaching rotation exhaustion.

We must this year either find Iraqis who will fight as hard as the “insurgents,” or find the will and the money to mobilize our forces, or retreat in disorder. All prospects for beneficial change in economic policy here (budget, taxes, Social Security) are hostage there. President Bush’s approval rating is back down to 49 percent, by 10-20 points the lowest rating upon re-election of any president since polling began, and 56 percent of the people think that Iraq wasn’t worth the trouble.

I hope and wish a happy new year; changed…pretty sure about that