A forecast by the Mortgage Bankers Association suggests that the economy will slow through the rest of 2006, but pick back up in 2007 and 2008. "Total residential mortgage production in 2006 will be $2.46 trillion, the fifth-highest level ever, but will drop another 14 percent in 2007 to $2.1 trillion and remain unchanged at that level in 2008," predicts the association.

That roughly echoes Moody's Economy.com report released in early October, "Housing at the Tipping Point - The Outlook for the U.S. Residential Real Estate Market," which predicted national home price declines in 2007 of 3.6 percent, but with precipitous drops approaching 20 percent in some areas.

Except that the MBA isn't as pessimistic, predicting home price gains will be so modest at 2 percent for existing homes and one percent for new homes. Even so, prices won't beat inflation (predicted to be over 3 percent) until 2008. Home prices have beaten inflation rates by one or two percentage points every year since 1968.

With 25 percent more homes on the market than last year, it's bad news for sellers who want to flip out of markets that have escalated in the double digits over the last five years, but it's also an opportunity to hold. If sellers aren't in a must-sell position, they can take their homes off the market and wait for some of the flipper inventory to be absorbed. They could then find themselves back on the upward appreciation swing again shortly.

The good news for buyers is that price declines increase affordability and with so many more homes on the market, they also have an ideal opportunity to improve their position -- they can afford the bigger house, the quieter street, the more prestigious neighborhood.

Doug Duncan, MBA chief economist explains why he believes a turnaround is in the making. "Despite sluggish growth, largely due to declining residential investment and auto production in the second half of this year, we are optimistic about a rebound in 2007," he says. "Long-term interest rates have remained low in the face of rising short-term rates, equity prices have risen nearly 20 percent, capital expenditures remain strong, the trade sector has turned from a big drag on growth to a modest stimulus, and energy prices have dropped sharply."

Duncan notes that while the "labor market has recently weakened, the market is still quite healthy." Employment continues to expand moderately, with payrolls increasing at an average monthly pace of 120 thousand over the past three months. Several measures of core inflation have trended higher in recent months, but we are optimistic that they will decelerate slowly to below the upper-end of the Fed's comfort zone."

"The financial markets perceive that the Fed is now done with the tightening cycle and now expect an easing at some point in 2007. Although we expect core inflation to moderate going forward, we believe that the currently elevated rate will keep the Fed from lowering interest rates despite signs of slowing economic activity. We expect that the Fed will keep the fed funds rate steady at the current 5.25 percent through 2008," he says.

Fixed-rate mortgages are currently just over half a percent more than 40-year lows, and Duncan expects them to remain low for the remainder of the year. "The 30-year fixed-rate mortgage yield should trend modestly higher over the course of the next two years, reaching 6.8 percent by the end of 2008. Thus, interest rates will still be quite low by historical standards," said Duncan.

Among his key points in the forecast:

1. Real GDP growth will average about 3.1 percent in 2006, 3.0 percent in 2007 and 3.2 percent in 2008.

2. The unemployment rate will increase from the current level of 4.6 percent to 4.9 percent by the end of 2006 and to 5.2 percent by mid 2007 and remain there through 2008, with about 90,000-100,000 jobs added monthly over the next 12 months.

3. Fixed mortgage rates should remain at about today's 6.3 to 6.4 percent through the rest of the year. Rates are expected to rise to about 6.7 percent by the end of 2007 and to about 6.8 percent by the end of 2008.

4. The yield curve remains inverted, with the fed funds rate and the 1-year Treasury yield exceeding the 10-year Treasury yield.

5. The yield spread between fixed and adjustable rate mortgages has remained at its lowest levels in over 5 years.

6. The share of adjustable rate mortgages has declined from 30 percent at the beginning of the year to 20 percent in August, according to the Federal Housing Finance Board (which only includes conventional loans for home purchase) and will continue declining to about 19 percent by the end of 2008.

7. The ARM share from the Mortgage Bankers Association weekly survey of mortgage applications (which include both purchase and refi loans) has shown a much more modest decline, however. The ARM share remained elevated at nearly 27 percent of the number of loans by mid October, compared with about 30 percent at the beginning of the year.

8. Total existing-home sales for 2006 will decline by about 9 percent relative to a record level in 2005, and will pull back by about another 8 percent in 2007. New-home sales will decline by nearly 18 percent from a record high in 2005 but will slip by about 8 percent in 2007. Both new and existing home sales will increase modestly in 2008.

9. Existing home price appreciation is expected to slow significantly this year, with median price gains decelerating to about 2.5 percent. Median new home price gains are projected to moderate to about 1 percent. Price gains for both existing and new homes in 2007 are expected to be similar to those in 2006. Home price appreciation should strengthen modestly in 2008.

10. Residential mortgage originations for purchase loans will reach $1.39 trillion in 2006 and will edge down to $1.32 trillion in 2007. Residential refinance loans will total $1.07 trillion in 2006 and then decline to $807 billion in 2007. For 2008, both purchase and refi originations should remain relatively flat to their 2007 levels.

11. Total residential mortgage production in 2006 will be $2.46 trillion, the fifth-highest level ever, declining by about 19 percent from an estimated $3.03 trillion in 2005 (the second-highest level ever). Total mortgage originations should decline an additional 14 percent to $2.12 trillion in 2007 and should remain flat in 2008.

12. The risks to the forecast lie mainly on the downside. The housing sector could deteriorate more than projected, with sharper declines in single-family housing starts and home sales, resulting in sustained declining year-over-year home prices. This could lead to a marked slowdown in consumer spending growth. If so, the Fed could start easing to prevent a recession. However, if core inflation remains elevated or even edges higher, the Fed would likely remain on the sideline, increasing the risk of a recession. The MBA believes the probability for this scenario to be small.

Homeowners, hang in there. Sellers, unless you have to sell, take your home off the market. Buyers, take advantage of low interest rates, falling home prices, and rising inventories to improve your position.