In general, housing prices tend to increase in line with personal income, since income determines how much a homeowner has available to spend on housing. From 1980 to 2001, that trend remained intact — median income rose 138% while housing prices rose 136% (Source: The Wall Street Journal, June 14, 2004).

However, recently, home prices have been increasing faster than income. From 1996 to 2003, income rose 22% while housing prices increased 47% (Source: The Wall Street Journal, June 14, 2004). One of the primary reasons for this divergence is historically low mortgage rates. With much lower mortgage rates, homeowners were able to purchase larger homes and still have a smaller mortgage payment.

Despite the rapid growth in housing prices, several studies indicate that housing may only be overpriced in selected areas, generally on the coasts. For instance, a recent study by economists at Wellesley College and Yale University found that housing prices were in line with income in 42 states. Housing prices in only eight states were higher than personal incomes would warrant (Source: Money, March 2004).

Generally, however, even those who believe housing prices are too high don’t believe there will be a housing crash similar to the recent stock market crash, for several reasons. First, the real estate market is not as homogenous as the stock market. Housing prices in one part of the country, even if vastly overpriced, have little to do with housing prices in other parts of the country. Second, most people don’t try to time the housing market. Even if housing prices seem high in your area, you’re not likely to move across the country for a cheaper house. You need to live close to where you earn a living. Third, while it is possible for housing prices to decline, it is generally felt that it is more likely for housing prices to simply level off for a while until personal incomes rise to match prices.

The concern is that now that the Fed has started raising interest rates, housing will become less attractive as rates rise. Fewer people will be able to afford the mortgage payments, putting pressure on housing prices.

With the future of housing prices looking uncertain, what can you do? Make sure you are living in a home you will be comfortable living in for at least five to 10 years. When housing prices are under pressure, the individuals who are hurt the most are those who must sell, usually due to a job change or because they can’t afford their home. As interest rates rise, individuals with adjustable rate mortgages could find their mortgage payments going up dramatically. If you’re barely able to make ends meet with the current low interest rates, you might want to lock in a fixed rate to remove that uncertainty.