By Jonathan Clements
From The Wall Street Journal Online

You can't go wrong with real estate.

Yeah, right.

I doubt we will see a nationwide real-estate meltdown. But who needs a meltdown? All it takes is weakness in some local markets, combined with a little personal misfortune, and things could get ugly for some homeowners.

Want to make sure your home doesn't turn into a house of horrors? Here are the five key risks in today's overheated housing market -- and how you can protect yourself.

• Borrowing heavily. Tell your friends you are buying stocks with borrowed money, and they will look at you like you're crazy. Tell them you purchased a $500,000 home with 5% or 10% down, and you will be showered with congratulations.

SMR Research calculates that, among home buyers who took out a mortgage in 2003, 61.4% borrowed more than 80% of the purchase price, sometimes taking out two separate loans. By the first half of 2004, the latest figure available, that number was up to 70.6% -- and today it is likely even higher.

"If we hit a spot where home prices cease rising or rise at a slower place, the high loan-to-value people will remain high loan-to-value," says Stuart Feldstein, president of SMR, a financial-services market-research firm in Hackettstown, N.J. "That tends to correlate with a high rate of defaults."

Today's leverage is especially worrisome given the steep rise in property prices over the past five years. If prices turn lower, those who made modest down payments could see their home equity wiped out, and might even be underwater.

The good news is, even if falling prices obliterate your equity, your mortgage lender can't insist that you immediately repay your loan. The bad news is, you may have to repay the loan anyway, because you have to relocate.

• Bad move. According to the National Association of Realtors, homeowners typically sell after six years. If you're buying in today's hottest markets, plan on staying put for at least that long, so you can ride out any market dips and build up some equity with your monthly mortgage payments.

What if you suddenly have to move -- and prices have stagnated since your purchase? If you had borrowed 95% initially, you could walk away with next to nothing once you figure in lawyer fees, moving costs and the 5% or 6% selling commission.

To avoid ending up as a renter again, consider making extra principal payments on your current mortgage or building up an emergency reserve, so you have enough money for your next house down payment.

• Problems adjusting. Last year, as folks struggled to afford increasingly expensive homes, 35% opted for various types of adjustable-rate mortgages. That compares with 18% in 2003, according to the Federal Housing Finance Board in Washington. ARMs offer a lower initial rate than traditional fixed-rate loans.

Now, however, these borrowers face rising monthly payments as short-term interest rates climb and their mortgage's low "introductory" rate disappears. Homeowners with interest-only mortgages face an additional hit, as their mortgage's interest-only period ends and accelerated principal payments kick in.

Indeed, even if interest rates stay fairly low, some borrowers could find themselves in a nasty financial squeeze. Suppose you took out a $300,000, 30-year "hybrid" mortgage for which the rate is fixed at 5% for the first five years but adjusts thereafter.

Your initial monthly payment would be $1,610. But in the sixth year, your rate leaps to 8%. Result: Your monthly payment would soar 32% to $2,126, according to the adjustable-rate mortgage calculator at www.dinkytown.net.

"You should take a look at a plausible scenario and see whether you can afford it," advises Keith Gumbinger, a vice president at HSH Associates, a mortgage-information provider in Pompton Plains, N.J. "Borrowers who have stretched themselves to the outer limits could be at risk. Adding a few hundred dollars to their monthly payment could be a deal breaker."

• Squeeze play. The deal breaker won't necessarily come from rising mortgage payments. If your mortgage is consuming much of your paycheck, your finances could unravel if, say, you get hit with big medical bills or you lose your job.

If you're barely managing to pay the mortgage now, you clearly don't have the cash to build up an emergency reserve. But you need some plan for dealing with financial setbacks, whether it's borrowing from your brother-in-law, tapping a home-equity line of credit, or even trading down to a cheaper house.

• Inspector remorse. You likely have a huge chunk of your wealth riding on your home. That's a risky position to be in, partly because you are making a big bet on one local market.

But even if you live in a buoyant market, you could lose money on your home, thanks to termite damage, a leaking underground oil tank or major structural problems. That's a real danger in the hottest markets, where buyers -- anxious to win bidding wars -- are making offers that aren't contingent on a home inspection.