The hot housing market has its good, bad and downright ugly sides, as super-high prices force first-time buyers into creative financing arrangements that could easily bust their budgets if the economy worsens.

To get into the housing market, some buyers are relying on loans that allow tiny down payments or interest-only and adjustable-rate mortgages, which have the advantage of low monthly payments early on. If interest rates rise, however, homeowners may discover they took on more risk than they can handle.

Federal Reserve Governor Susan Schmidt Bies, speaking to the North Carolina Bankers Association Tuesday, expressed concerns that as the housing boom continues, buyers may become increasingly speculative. In turn, banks could bend to competitive pressures and lower their underwriting standards, which appear to be weakening already. “For example,” she said, “ 'affordability products' - such as interest-only loans, negative amortizations, and second mortgages with high loan-to-value ratios - are becoming more popular; subprime lending is growing faster than prime lending; adjustable-rate mortgages, or ARMs, have grown substantially and now account for more than a third of all mortgage originations, the highest level since 1994.”

A new study by the Joint Center for Housing Studies at Harvard University stated that the rapid increase in interest-only loans suggests “that more buyers are hitting the wall on affordability.” The report continued, “For now, though, house prices should keep rising as long as job and income growth continue to offset the recent jump in short-term interest rates. House prices would come under greater pressure, however, if the economy stumbles and jobs are lost.”

The report, The State of the Nation's Housing: 2005, says that one in eight U.S. households are spending half their income on housing costs, while one in three dedicate a third of their income to housing.

The residential real estate market should continue to be strong over the next 10 years, which is good news for those already owning a home. The report also says, however, that prices are out of reach for many would-be homeowners, as there are 33 metro areas where homeowners pay at least four times their income for a home. Five years ago, that number was 10. Also, the report says that more homeowners are tolerating longer commutes to be able to buy a home in an affordable area.

"For owners already in the real estate market it has been a great ride," Richard DeKaser, chief economist at National City Corp. told USA Today. "But ... (non-owners) are increasingly being shut out or resorting to unusual means to get in."