Home prices fell for the third straight month in October, settling at a 3.5 percent fall from October 2005, a new record. Then, in November, when home prices fell again, that became the first time ever that sales prices compared to the year before fell for four months straight.

For prospective buyers and sellers, the big question is whether or not recent record home price drops signal a market bottom, or whether they are evidence of a snowballing home price downturn.

In an article titled, “Has Housing Bottomed in the U.S.? Data and Fifth-Grade Math Says NO,” Jas Jain reports that the housing market will probably continue to fall because the supply of newly constructed houses continues to vastly outstrip demand.

He says that the “3 million empty housing units added since 2002 will swell to 4 million by the end of 2007 due to what is in the pipeline already ….” If he is correct, that means that since there were 9.5 million empty homes in 2002, homebuilders have increased the supply of unoccupied homes by 42 percent in just 6 years.

Other headlines reveal that foreclosures are also predicted to boost further the supply of for-sale properties.

Last month, the New York Times ran an article revealing that subprime loans (loans made to people who under normal circumstances could not qualify for a loan) now make up more than a quarter of the total mortgage market. The study suggests that these “risky lending practices could lead to the worst foreclosure crisis in the modern mortgage market,” and that 2.2 million borrowers who have taken subprime loans since 1998 are “likely to lose their homes.” According to Peter Schiff of Euro Pacific Capital, “the idea that subprime foreclosures will not affect the broader market is absurd.”

But even considering the supply/demand fundamentals and the number of sub-prime loans, the biggest threat to the housing market may be the high number of adjustable rate mortgages (arms) that began resetting during 2006 and are continuing to do so in 2007.

Senior market strategist Michael Pento of Delta Global Advisors says that much of the past year’s rise in mortgage defaults is a result of the 22 percent of the $8.7 trillion in mortgages held by Americans that reset during 2006. That means a “typical three-year arm will go from 3.6 percent to 5.6 percent. On a $500,000 mortgage, the monthly payment would increase by $800 ….”

Another $1 trillion will reset in 2007. Some people could see their monthly payments rise by as much as 50 percent (New York Sun,Dec. 20, 2006).

Then there are all the “liars’ loans”—loans that require little or no documentation to confirm the borrower’s actual income—which have also become very popular over the past few years. Dan Dorfman reports that while in 1998, liars’ loans composed a disturbing 24 percent of all mortgage originations, in 2006, they shot up to an incredible 62 percent of mortgage originations.

The problem with these low-documentation loans is that most home buyers lie about their incomes. Consequently, an increasing proportion of homeowners are living in homes they do not realistically have enough money for.

According to a recent survey, “90 percent of the income statements [on these types of mortgage applications] were exaggerated by 5 percent or more, while almost 60 percent of the stated amounts were exaggerated by more than 50 percent“ (ibid.; emphasis ours).

In response to soaring financial burdens, “Untold numbers of homeowners will simply no longer be able to afford their homes,” says Steven Krystofiak, president of the Mortgage Brokers Association for Responsible Lending (ibid.).

Don’t believe the majority thinking on Wall Street that says the housing slump will bottom out shortly, he says. Delinquencies, foreclosures and homeowners trying to sell their depreciating and increasingly unaffordable homes could be about to rise.

The full brunt of the housing weakness may have yet to be seen.