Question: If interest rates were to rise, what effect would this have on home values, including the value of rental properties?

Justin: Higher interest rates would likely put downward pressure on home prices. But don't fret just yet -- the damage, while possibly serious, might not be as bad as you think.

First, the bad news: There's little doubt that higher interest rates can create trouble. Say you're buying a $250,000 home and getting a 30-year, fixed-rate mortgage at 6% interest. Your payments will be about $1,500 a month. But if the interest rate for that same loan suddenly rose to 8%, the monthly payment would be about $1,835. If the rate shot up even more dramatically to 12%, a level last seen in the mid-1980s, the monthly payment would jump to $2,570.

Economists don't believe rates are headed anywhere close to the levels seen in the mid-1980s, but they do believe rates are likely to increase, perhaps by a percentage point or more over the next year as the U.S. economy picks up momentum. Even a slight change in monthly payments could push some buyers out of the market. Some families can barely afford to qualify for a home at current interest rates, and if their monthly payments were to rise by $50 or $100, they might opt to rent instead, resulting in fewer home sales. That reduced demand should put downward pressure on home prices.

According to a 25-city analysis by Fidelity National Financial Inc., a real-estate services provider, some of the cities that have seen the biggest price appreciation in recent years could suffer outright price declines if interest rates climb significantly. For example, a median-priced home in Boston now worth $407,000 would see its price drop by $59,000 by 2006 if the rate on a 30-year loan rose to 8%. In Los Angeles, median prices would fall about $45,000, while in Seattle they would drop about $25,000. Washington, D.C., median home prices would decline about $39,000. Many cities where the housing markets are less overheated wouldn't be hit as hard; for example, Cleveland, Phoenix, Minneapolis, Miami and many other major cities would still enjoy price increases. But even in those cities, the rate of appreciation would likely be slower than if rates remained a lot lower.

Now for the good news. Michael Sklarz, chief valuation officer at Fidelity National Financial, points out that even if some cities suffer big price declines, property owners still might not be all that bad off given the sharp run-up in prices in recent years. That's because declines like the ones possible in Boston most likely wouldn't be enough to offset the huge gains many property owners enjoyed in recent years. What's more, the price drops "could be short-term declines before the longer-term upward trend reasserts itself," he says.

It's also worth noting that some factors could offset any downward price pressure from higher rates. For example, many analysts argue that higher rates would come about only if the economy is healthy again, and if that happens, there should be more jobs, which in turn could actually boost demand for housing. While that might not be a powerful enough force to send home-price appreciation soaring, it could help keep prices from tanking. Also, if many borrowers switch to adjustable-rate mortgages or other loans designed to eliminate some of the sting of rising rates, the impact of higher interest rates could be reduced.

Karl "Chip" Case, an economist at Wellesley College and one of the country's leading authorities on home prices, argues that higher interest rates could actually help prop up prices in some places by reducing the supply of available homes. When interest rates climb, many people who own houses choose not to move, because they don't want to swap their older, low-interest mortgages for loans issued at the newer, higher rates. As a result, fewer homes come on to the market, reducing the supply of available properties. And while demand for homes would likely fall in a higher interest-rate scenario, if supply declines, the remaining buyers would have fewer properties to choose from, which in turn could help keep prices from falling dramatically.

Mr. Case cites the example of San Francisco and Vancouver, Canada, in the early 1980s. Back then, 30-year mortgage interest rates were as high as 18% from 9% just a few years earlier. In Vancouver, where many borrowers had adjustable-rate mortgages that quickly became more costly, many owners decided to sell their homes to get out from under their new, higher-cost loans. Prices fell 60%. But in San Francisco, which had a far higher percentage of fixed-rate loans, many owners opted to hang on to their properties, and prices held firm.

Mr. Case argues that the bigger issue with interest rates isn't how high they go, but why they're rising. If rates are rising because of big problems in the economy, like a collapse in the value of the dollar, then housing will most likely get hurt. But if rates are rising because of faster economic growth, aided by a hiring boom, your property value might not go down at all.

As for the rental market, most analysts believe higher interest rates are actually good for it. The rental market has suffered tremendously in recent years in large part because so many families have taken advantage of low interest rates to move out of apartments and buy houses. But if rates go back up, many of the families that would have purchased homes could decide to stay put, helping to stabilize the rental sector. Also, higher rates would make it costlier for developers to build new apartment buildings, forcing them to scale back on adding new supply. That would help ease a glut in rental properties, further bolstering the market.

-- Mr. Barta is a staff reporter for The Wall Street Journal. His "House Talk" column appears every Friday exclusively on RealEstateJournal.com. Click here to e-mail him your questions about the residential real-estate market. Please include your first name and city and state. If your question is answered and posted, we will show your first name and city.