The housing market is mounting a solid recovery, right? I sure would like to believe that.

The Case-Shiller index report from earlier this week showed that home prices across the country spent yet another month climbing out of the pit, notching a 1% month-over-month increase. While this compares poorly with the 11.3% year-over-year drop, it's a sign that prices are moving in the right direction.

This is good news, no? Sure it is, but there are a number of behind-the-scenes factors that have been propping up buying, and we can't expect these to stick around forever.

Free money
"Psst. Thinking about buying a house for the first time? Here's $8,000 to help you make up your mind."

That welcome mat has greeted first-time homebuyers ever since the government introduced its much-ballyhooed first-time homebuyer tax credit. The idea is that by offering some government cheese, homebuyers will be more inclined to help gobble up the massive inventory of unsold homes. The approach is nothing new, consumer products companies offer rebates all the time to entice buyers to pony up for their products.

But the question is how long Uncle Sam can keep up this handout. As my fellow Fool Morgan Housel pointed out earlier this week, the country's national debt is no joke and programs like this only stoke that fire.

The tax credit is set to expire at the end of November, but the mere fact that lawmakers are diligently working to extend it shows how much concern there is that pulling back this incentive will put the market back in the doldrums.

Close to free money
Mortgages may not be free money right now, but they're as close to free money as they have been in a long, long time -- if not ever. lists 30-year fixed mortgage rates at a mere 5.2%. How does that stack up historically? Let's take a look-see.


30-Year Fixed Mortgage Rate













Source: HSH Associates and

There has been a very clear downward trend in mortgage rates since the '80s, but do we really want to bet on rates staying at these historically low levels? These levels are largely driven by the nearly free money that the Fed is giving banks through its obscenely low federal funds rate -- a situation that can't continue if we hope to keep the dollar out of the toilet.

The problem here is that whether we're talking about homebuyers looking for shelter or real estate investors looking for profit, higher interest rates negatively affect the amount that they'll be willing to pay for a house. For homebuyers, higher interest rates will mean that monthly payments will start creeping up, while investors will see a lower return on their investment when they have to cope with a higher interest rate.

In either case, for any given house, buyers will be looking for an incrementally lower price as rates rise.

And in terms of even getting a loan, don't forget that in the middle of all of this, the on-life-support Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) have been playing a huge role as they've been pushed by the government to bend over backward to offer loans to an ever-widening breadth of the market -- a situation that's likely unsustainable given the state of the two companies.

That darn inventory problem
Living at ground zero in Las Vegas, I get a much bleaker picture of the housing market than elsewhere in the country, but many of the things that are happening here are no doubt taking place elsewhere in the U.S.

For instance, the other day I overheard a real estate agent saying that the Vegas market was looking good because inventory is rapidly depleting. While that may be true for homes that are actively on the market, my experience has been that banks have kept recently foreclosed homes off the market for some time. This ensures that there will be a steady supply of empty homes that will continue to hamper the market's recovery.

This, of course, doesn't take into account the potentially vast numbers of homeowners who are on the verge of foreclosure or will be when adjustable-rate mortgages reset in the coming years.

Don't be afraid, be ready
The impact of this hits investors in two primary ways. First, it paves a tough road for homebuilders and their suppliers. Whether it's KB Home (NYSE:KBH) actually selling homes, or USG (NYSE:USG) selling wallboard to those homebuilders, competing with foreclosures and other highly motivated sellers will continue to be brutal for business.

Meanwhile, mortgage lenders like Wells Fargo (NYSE:WFC), which now has Wachovia's portfolio to deal with; Bank of America (NYSE:BAC), with its massive Countrywide exposure; and JPMorgan Chase (NYSE:JPM), along with all the Washington Mutual garbage; will no doubt continue to struggle with foreclosures and loan writedowns.

But the impact goes beyond companies directly tied to housing. Businesses that thrived on spending from consumers borrowing against their home equity, as well as those that sold goods and services to new homeowners outfitting their homes will continue to scrape by.

But the message here isn't to cash in all of your stocks for gold bullion and bottled water. Instead, when you're evaluating your portfolio and new investments, be sure to consider the impact of continued struggles from the housing market.

Having trouble cutting a stock from your portfolio? My fellow Fool Adam Wiederman shares some relationship tips for the individual investor.

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Fool contributor Matt Koppenheffer (still) owns shares of Bank of America, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool. The Fool's disclosure policy is dressing as a dragon for Halloween.