How to defuse a ticking home loan

You can get your credit reports once a year for free from AnnualCreditReport.com, but scores are not free. To get FICO scores, which are the same scores mortgage lenders use, you'll need to pay about $50 at MyFico.com, the only site that sells FICOs for all three bureaus. Mortgage lenders typically base their decisions on the middle of the three scores, or the lower of the two middle scores when lending to a couple. You also can get an approximation of your scores with MSN Money's credit-score estimator.

You may be able to boost your scores by successfully disputing serious errors on your report, such as accounts that aren't yours or late payments that actually were made on time. Another tactic for quick score improvement: pay down credit card balances and use your cards lightly. The less of your credit limits you use at any given time the better. Using 30% or less of your credit limits is good; less than 10% is even better. Because balances are reported monthly, improvements in your scores should show up quickly. Read "7 fast fixes for your credit score" for more tips.

Get real about your equity. Refinancing to a different loan will be tough, if not impossible, without at least some positive gap between what your home is worth and what you owe. Home-value estimators such as Zillow, RealtyTrac and Domania can get you started, but you may get a more accurate figure by talking with several real-estate agents who are familiar with your neighborhood. If home prices are dropping in your area, understand that lender appraisals may be getting more conservative as well.

Start shopping. If you can refinance, your next step is deciding whether you should. You can research your options at FreeRateSearch.com, LendingTree.com and other sites.

What you should do next depends on the specifics of your situation.

If your current, fully indexed rate is significantly higher than the rate you could get with a no-cost refinance, mortgage expert Jack Guttentag recommends jumping to a new loan, assuming there's no prepayment penalty. (Guttentag's site, the Mortgage Professor, includes an article about whether to refinance an adjustable rate into a fixed-rate loan, as well as other information about refinancing.)

If the new rate isn't much better, though, and you can handle the bigger payment, you might just stick with the loan you have, Guttentag said.

"Ninety-nine percent of ARM borrowers approaching a rate reset face a rate increase," said Guttentag, "but it could be small, and if there is a prepayment penalty, it might not pay to refinance."

Detweiler, of FreeRateSearch.com, votes for fixing your rate if you can. She notes that rates, though higher, still are near generational lows, and she thinks the gap between fixed and adjustable rates isn't great enough to justify going with an adjustable loan's greater risk. That's true for folks with good credit as well as for those with troubled credit.

Here's an example. Someone who in September 2005 opted for a two-year hybrid mortgage for $250,000 and who had a credit score of 615 could have qualified for a loan with a payment of about $1,579 a month. In September 2007, the payment on his loan would be scheduled to rise to $1,906, a 21% increase.

Because rates have risen overall, jumping to another two-year loan wouldn't save much: less than $100 a month. Switching to a 30-year fixed rate would, by contrast, result in a payment of about $1,881 a month, just $60 more than the two-year hybrid.

Can't cope? Talk to a housing counselor. If you think you can't swallow a bigger payment and you have no equity in your home, Detweiler said, it's time to call for help. A HUD-approved housing counselor can discuss your options and offer budgeting assistance to see whether there's a way to handle the new payments.

If not, your last best hope may be selling the home before foreclosure. Read "Facing foreclosure? 9 options" and "Your lender doesn't want your house" to better understand your alternatives when you're facing default.

Liz Pulliam Weston's latest book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.

Updated Oct. 22, 2008

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