Adjustable-Rate Mortgages

The good news out of the University of Southern California's Lusk Center for Real Estate is that experts there see no pricing bubble in the California housing market. The bad news is that they are concerned about current high use of adjustable rate mortgages - especially down the road, as more of these loans convert from fixed to adjustable rates.

"If interest rates increase, some buyers may not be able to afford higher payments and may have to sell their homes," says Raphael Bostic, Ph.D., a former Fed economist who specializes at Lusk in tracking the home mortgage market. Bostic concentrates on the Southern California market, but his concerns have national implications because ARMs have recently accounted for about a third of new loan applications nationally, the highest in a decade. Some lenders are even packaging ARMs with interest-only, 100% financing.

If too many ARMs go into default, "this could cause a sudden rush of homes on the Southern California market and depress prices," Bostic says.

On recent concerns about a possible pricing bubble in Southern California, Bostic points to the region's continuing strong employment growth as evidence home prices are not artificially inflated. "As interest rates increase, the region's home sales will slow to more moderate, but sustainable, levels and prices will increase more slowly," he reasons.