SANTA CRUZ (December 14, 2008) - Everyday someone asks me what I think mortgage rates will do and where are home prices headed. The answer is relatively simple. While I don’t know how much lower rates can go and I don’t know if home prices have hit the bottom yet, I do know with certainty that both mortgage rates and home prices will eventually be going up.

The stars are currently in alignment for homebuyers. Home prices are at levels we have not seen for years, many sellers are anxious to sell and willing to negotiate, mortgage rates have recently dropped about one full percent and there is clearly no shortage of mortgage funds for homebuyers who can afford to buy a home.

Did you know that the mortgage industry offers homebuyers the ability to buy a home without any money in the bank? The minimum down payment of 3.5 percent may be all gift and the closing costs may be paid for by either a relative or the seller. Furthermore, there is no cash reserve requirement. That is, unlike conventional financing, the homebuyer does not need to have any money in the bank when escrow closes.

Additionally, we allow homebuyers to spend up to 55 percent of their gross monthly income (for self employed, we use a two year average of the adjusted gross income as reported on the borrower’s Schedule C of their Federal tax returns) on their combined monthly debts. That is probably as high of a ratio as any family would consider affordable or comfortable.

Regarding rates, keep this ratio in mind: one percent in rates is equivalent to about 10 percent in sales price. The recent drop of one percent in the 30 year fixed rates translates to a reduction in the effective sales price of a home of 10 percent. For example, a home purchased today for $400,000 with 10 percent down would require a principal and interest payment of $1934 at 5.00 percent. However, waiting for a lower price could be expensive.  To keep the payment at $1934 when rates rise back to 6.00 percent would only allow the homebuyer to buy a home for $360,000.

The talk this week from the Treasury Department and Freddie Mac and Fannie Mae about rates dropping to 4 percent or lower could create a mini boom in home sales. The result may be a mixed blessing. Homebuyers may want to wait for lower rates and sellers, sensing a rush of offers, could become less likely to negotiate.

A rate drop to 4 percent would allow the homebuyer in the above example to buy a home priced at $450,000. With 10 percent down, the principal and interest payment would remain at $1934. More buyers able to qualify for higher priced homes could result in rising home prices.

Once sellers sense that home prices have hit the bottom and are on the rise, they will no longer be so pliable when it comes to negotiating. Homebuyers who are getting into their homes with little or no cash absolutely must get help from the seller to help with the closing costs. Closing costs can run $10,000 to $15,000 when factoring in 7 months of property taxes, 14 months of homeowner’s insurance and up to 30 days of mortgage interest.

Waiting for home prices to bottom out is not a reliable strategy. Remember, no one will know that home prices have hit bottom until home prices are on the rise again and by then it may be too late.

This column is written every Sunday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 of email him at Peter@SantaCruzHomeFinance.com.