Rock-bottom interest rates have fueled an epic housing boom while an economic slump has hammered technology, manufacturing, transportation and other sectors.
So what happens when mortgage rates begin to increase?
Although the Federal Reserve recently trimmed short-term rates, mortgage rates have been on the rise. On Thursday, the average rate for a 30-year fixed mortgage bounced up to 5.52 percent from 5.4 percent the week before, according to mortgage giant Freddie Mac.
That momentum could spell bad news for consumers. If rates continue going up, analysts say:
-- Fewer new home buyers would be able to afford monthly mortgage payments.
-- That in turn, could throttle price increases and even force them down, choking the refinance market and dampening consumer spending.
-- Moreover, homeowners with adjustable-rate mortgages will see their monthly payments jump.
David Jamison, who has a 30-year adjustable mortgage, has seen the payment on his three-unit building in Buena Vista Park drop by about $24,000 a year as short-term rates have plunged. Later this year, however, he expects his monthly payments to increase as interest rates rise. Before they climb too far, the advertising executive hopes to convert to a fixed-rate mortgage.
"Very, very quickly, it could start to cost substantial amounts of money," he said. "That's why I want to get this resolved by the end of the year."
FED'S ACTIONS
Interest rates have remained low because the Federal Reserve, in an effort to buoy the economy, has lowered short-term rates. But there isn't always a direct connection between short-term rates and longer-term interest rates, such as bonds, on which mortgage rates are often based. Usually, a sluggish economy triggers lower mortgage rates, while a stronger economy means higher rates.
The fed has continued to cut short-term rates, which has helped boost consumer confidence and the stock market. That leads some experts to believe the worst of the economic doldrums are over and mortgage rates will start to shimmy upwards through the remainder of the year.
"It's only low interest rates that have kept housing going," said Ken Rosen, a real estate and economics professor at UC Berkeley. "If we lose that, we'll start to see house prices going down. It's inevitable."
Other experts, however, contend the recent uptick does not signal a large- scale rise in home loan rates, pointing out that the rate is still more than one point below the 6.54 percent average for the same period last year. In fact, they believe the economy will bump along slowly in the short-term, keeping a lid on mortgage rates and a flame under the housing market.
The debate over interest rates notwithstanding, one thing about the housing market is certain: The sector has provided an important crutch for the ailing U.S. economy.
The national median home price jumped from $133,500 in the first quarter of 2000 to $161,500 in the first quarter of 2003, a 21 percent increase, according to the National Association of Realtors.
PASSIONATE INTEREST
Those price gains have allowed millions of consumers -- many of whom seem to follow home prices and interest rates the way baseball enthusiasts pore over box scores -- to refinance and pay down debt, renovate their homes and buy cars, clothes and other goods.
It would take only a relatively small increase in interest rates to change that, particularly in areas with high home prices.
For example, a 7 percent rate on a typical 30-year home loan -- up from the current 5.5 percent -- in 2004 could push the median home price down in the San Jose metropolitan area by 14.3 percent, according to Michael Sklarz, a researcher who studies home values for Fidelity National Information Solutions, a real estate research firm.
That same rate would squeeze San Francisco home prices by 6.7 percent. In Oakland, home prices would remain unchanged, in part because prices there have risen less rapidly and are therefore less sensitive to rate changes, Sklarz said.
A 6 percent loan could dampen home prices by 4.2 percent and 1.2 percent in San Jose and San Francisco, respectively. Prices in Oakland likely would increase slightly, Sklarz's data show.
"It's not a disaster, it just means people who bought in the last year or two probably won't see any gains of substance for the next three or four years, " Sklarz said.
HOME PRICE DROP PREDICTED
John Talbott, a visiting scholar at UCLA's Anderson School and the author of the book "The Coming Crash in the Housing Market," is more bearish. He predicts that Bay Area home prices will drop dramatically as interest rates escalate because fewer people will be able to afford to buy.
"Banks will be willing to lend people less money," Talbott said.
On a monthly basis, a small rise in interest rates can have a large impact on a household's cash flow. The typical monthly payment on a $400,000 mortgage over 30 years at 5.25 percent totals $2,209 (that doesn't include property taxes or insurance). At 6.25 percent, the sum jumps to $2,463, and at 7.25 percent it grows to $2,729.
At that level, new home buyers may be stretched to meet monthly mortgage, property tax and insurance obligations and would have less cash left over to spend on other goods. Lower home prices also mean consumers have less equity to tap. According to mortgage industry estimates, refinancing activity is expected to plunge 50 percent over the next year or so.
In a worst-case scenario, interest rates rise, housing prices slump and the economy stumbles. Consumers could be faced with a double whammy: shrinking incomes and plunging home values -- a combination that could cascade through the entire economy.
"If that happens, we could go into a double dip" recession, Rosen said.
TIMING IS IMPORTANT
That's why some economists say timing is so important -- particularly for the Bay Area, where the short supply of housing makes the market especially volatile. If the national economy were to rally, interest rates could be driven higher. But if the Bay Area languished, the demand for housing could be curbed sharply here.
"The diversification of the Bay Area economy doesn't match the diversification of the U.S economy overall," said Stuart Gabriel, director of the University of Southern California's Lusk Center for Real Estate.
"If the U.S. economy improved and the Bay Area remained weak . . . that would undoubtedly slow the Bay Area housing market."
On the other hand, such a scenario doesn't appear likely, Gabriel noted. For one, few economists predict a quick rebound. Second, for interest rates to rise substantially there would have to be significant improvements in the economy, which would prop up consumer spending and help offset any financial impact from falling housing prices.
What's more, a chronically tight housing supply in California will help safeguard the housing sector from falling or even plateauing prices, experts say.
"In real estate, the pricing structure is pretty sticky on the way down," said Drew Kusnick, president of KB Homes South Bay division.
SOME MODERATION
Locally, prices on homes above $1 million already have moderated. For homes below that level, sales and prices have remained strong. The San Francisco metropolitan area's median price for an existing detached home jumped from $418,000 in the first quarter of 2000 to $509,000 in the first quarter of 2003, according to the California Association of Realtors.
At the same time, the region has borne the brunt of the technology meltdown and has lost hundreds of thousands of jobs.
That clearly shows that the Bay Area housing market, among the nation's most expensive, has become unmoored from the larger economy and reached unsustainable levels, some pundits say. Even a small bump in interest rates could force a hefty price correction, according to researchers.
"The Bay Area has to find a new equilibrium with the rest of the country," said Ed Leamer, director of UCLA's Forecast. "You can't afford to have one region of the country where the housing stock is way out of line with everyone else."