The signs of better times are evident -- home sales, housing starts and building permits, the traditional measures of the housing market's strength, are up. Interest rates are down, and droves of prospective buyers are out looking for their dream homes.

The housing recovery, although modest by the standards of post-recession upturns experienced since World War II, is definitely here. And while there is some disagreement among economists and housing experts as to its staying power, most observers expect it to be around at least for the rest of the year.

Mortgage interest rates began dropping late last summer, from an all-time high of between 17 and 18 percent. The rates hit 12 to 13 1/2 percent in December, and have remained there, bringing out buyers who had not been able to afford a new home for several years.

Margaret Gallen, who rents an apartment in the District, said the small two- and three-bedroom town houses she looked at last weekend in Alexandria are "what I need, and the price is okay." The lower interest rates have made buying "something I can think about."

"It's terrible when you think about years past when everyone owned their own homes. Now many people can't even think about it," she said.

The number of people who can consider owning a home has increased dramatically in the last few months, however, say local developers and real estate brokers. They report large increases in the number of shoppers and more sales than in the last three years.

"People who were squeezed out earlier are finding now that they can buy a house. They're out looking," said Jack Queen, general manager of Maryland and D.C. operations for Long & Foster Realtors.

Most buyers want new homes, and they find that the "drop from 17 to 12 percent interest rates makes a big difference in the monthly payments," he added. For example, 17 percent interest on a $100,000 home requires a monthly payment of $1,425. The payment drops to $1,028 if the interest rate is 12 percent.

Builder Martin Poretsky described his company's business this year as "dramatic." Sales already have reached 80 percent of the number the company sold during all of last year. The firm, Poretsky and Starr, builds single-family detached homes and town houses in Fairfax and Montgomery counties for prices ranging from $70,000 to $140,000.

Chevy Chase-based developer William L. Berry said his sales took "a significant upturn from the third week of January and peaked out in March." April sales are down, but remain higher than they have been in the same month for the past few years, he said.

Throughout the nation, sales of new homes were 49 percent higher and resales were 24.1 percent higher than the same month last year, the National Association of Realtors reported. Housing starts dropped by 9 percent in March from the previous month, but the seasonally adjusted rate of 1.6 million was 75 percent higher than the rate for March 1982.

FHA interest rates were the first to decline, dropping 1 to 1 1/2 percentage points below the conventional rates. Consequently, FHA loan applications shot up, to hover at about 1.4 million in late 1982.

About 30 percent of these applications were from homeowners seeking to refinance their higher-rate mortgages. The remainder were for home purchases and "shows the strong borrower preference for a fixed-rate mortgage, which is assumable and has no prepayment penalties," according to the Center for Real Estate and Urban Economics at the University of California, Berkeley.

Many developers and lenders expect high sales rates throughout this year and most of 1984, boosted by perhaps another 1 to 1 1/2 percent drop in interest rates.

Beyond late 1984, however, the outlook becomes gloomier, say many in the industry.

The prospect of high federal budget deficits for the remainder of the decade is "why we consider this recovery somewhat fragile," said Harry Pryde, president of the National Association of Home Builders.

The builders, bruised by three years of losses in the worst market in four decades, fear the recovery is already losing steam: "It is becoming increasingly obvious that the spurt of activity generated by the sharp drop in interest rates last year is petering out," says the NAHB's April economic report.

The report said that unemployment in the construction industry rose to more than 20 percent again in March after a temporary dip in February, that the prices of building materials are going up and that foreclosure and delinquency rates continued to rise in the last quarter of 1982.

The Berkeley research center also believes "the embryonic recovery . . . is substantially threatened . . . " Possible federal deficits of $200 billion to $300 billion per year in coming years are "the main threat to the economic and housing recovery . . . and the high level of real, long-term interest rates they continue to encourage," according to a report prepared by the Berkeley center.

The economy and the housing market are "kind of in place for a classic recovery led by consumers, and later long-term investment to sustain it, but the problem is the federal government," said Mark J. Riedy, executive vice president of the Mortgage Bankers Association.

Riedy is optimistic about the current upturn, and predicts that "interest rates are likely to come down a little . . . there is just enough credit to go around, and I see no reason interest rates can't come down a point and a half."

For the remainder of 1983, "We think rates will be pretty much in the range they now are, that is 12 1/2 to 13 percent," said David O. Maxwell, chairman of the Federal National Mortgage Association, or Fannie Mae. "Next year they might even be a bit lower, and 12 percent is pretty much a floor, as far as we can see."

Few, if any, industry experts dare to speculate when, if ever, interest rates will drop into the one-digit level. Renay Regardie, president of Housing Data Reports, which surveys the Washington metropolitan housing market, believes "we're in the double-digit mortgage rate forever and ever. The lowest we might even anticipate might be 11 1/2 percent."

Even these rates, however, "are still far too high for millions of American families," said NAHB President Pryde.

Fannie Mae calculates that "every percentage point of increase in interest rates subtracts 150,000 housing starts," said Maxwell.

"Clearly the market is terribly rate-sensitive. The one thing that's hard to figure is where is that sensitivity," he added. "I can remember when home mortgages were 6 percent. Every time they went up by a percentage, people said, 'That's the end.' When they hit 10 percent, it was an appalling shock. Now here we are at 12 1/2 percent and everybody regards it as a great blessing."

Buyers can expect in the near future to face price increases along with the higher-than-ever interest rate floor. New-home prices will increase most "because the material to build them is going to become short and the price is going to go up," said Herman Methfessel, Virginia general manager for Long and Foster Realtors.

Fannie Mae Chairman Maxwell agrees that prices will go up, although not "at anywhere near the rate they went up in the 1970s. There will be some increase because of pent-up demand in market, and the cost of land remains very high."

Builders also are concerned about the rising cost of materials. The price of lumber has increased about 25 percent over last fall, said NAHB president Pryde, whose home is in Seattle, deep in timber country. The industry was "caught with a short supply of lumber" when the recovery began, because many lumber mills were shut down during the recession.

Prices of nearly all materials are going up, after the "all construction materials" component of the Producer Price Index jumping from a 3 percent annualized rate in December to 19.8 percent in February.

Frank Gordon, a Fairfax County builder, estimated that materials have gone up by as much as 10 percent since the recovery began, with three lumber price hikes in the last 10 weeks. He said a 10 percent materials increase adds from 3 to 4 percent to the price of a finished home.

In an attempt to compensate for higher prices, some developers are building smaller houses.

A housing market newsletter reports that in some areas of the United States, small, detached houses ranging from 800 to 1,000 to 1,200 square feet are selling well for prices that range from "the high 40s to the low 60s."

The NAHB says its members report "a major down-sizing of units . . . from 1,706 square feet in 1982 to a proposed 1,478 square feet in 1983 . . ."

Renay Regardie believes the "trend toward smallness is not just affordability, but to some extent a reflection of changes in society. Over the last decade in Washington, the average household size has decreased . . . and there is a large percentage of single-parent households. A lot of this is here to stay. People get divorced after two kids and after they have moved up to a big house. After the divorce, the one with the kids needs a townhouse and the one who has them on weekends needs a condo."