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updated 7/6/2010 2:45:12 PM ET 2010-07-06T18:45:12

The housing market may be on the verge of taking another plunge that could weaken the broader economic recovery.

Sales of previously occupied homes are dipping even though buyers can still benefit from government tax credits. And nearly a third of sales in May were from foreclosures or other distressed properties. That means home prices could be heading downward after stabilizing over the past year.

Last month's sales fell 2.2 percent from the previous month to a seasonally adjusted annual rate of 5.66 million, the National Association of Realtors said Tuesday. Analysts who had expected sales to rise expressed concern that the real estate market could tumble once the benefit of the federal incentives is gone entirely, starting next month.

"The outright decline in May sales is stunning given the last-ditch effort on the part of buyers to claim the tax credit," Sal Guatieri, an economist at BMO Capital Markets.

Sales have climbed 25 percent from the 4.5 million annual rate hit in January 2009 — the lowest level of the recession. But they're still down 22 percent from the peak rate of 7.25 million in September 2005.

The report counts home sales when a deal closes. So federal tax credits of up to $8,000 for home buyers likely influenced May's results. The deadline to get a signed sales contract and still qualify was April 30. Buyers must close their purchases by the end of this month.

The tax credits were expected to lift sales in May and June. Lawrence Yun, the Realtors chief economist, said delays in the mortgage-lending process put about 180,000 potential buyers in limbo. They are unlikely to qualify by the June 30 deadline. The trade group is pushing Congress to extend the deadline for closing a sale until Sept. 30.

Another troubling sign is the number of foreclosures and short sales — which happens when the lender agrees to accept less than the total mortgage. They made up 31 percent of sales in May. And those numbers could rise in the coming months as government efforts to help at-risk homeowners have been unsuccessful.

More than a third of the 1.2 million borrowers who have enrolled in the Obama administration's $75 billion mortgage modification program have dropped out. About 340,000 homeowners, or 27 percent of those who started the program, have received permanent loan modifications and are making payments on time.

The May drop was led by a more than 18 percent decline in the Northeast. Sales were unchanged in the Midwest, but rose nearly 5 percent in the West and 0.5 percent in the South.

The inventory of unsold homes on the market dropped 3.4 percent to 3.9 million. That's an 8.3 month supply at the current sales pace, compared with a healthy level of about six months. The median sales price in May was $179,600, up 2.7 percent from a year earlier.

First-time buyers made up 46 percent of sales.

The report "suggests that even government stimulus in the form of a tax credit isn't enough," to support the U.S. housing market, wrote Guy LeBas, an analyst with Janney Montgomery Scott.

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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