Time to refinance -- or buy a home?

By SmartMoney

Between holiday shopping and decorating the house this weekend, carve out some time to review your mortgage or rethink your home-buying plans -- this just might be the perfect time to make a major move.

Mortgage rates are already hovering around 5.5%, the lowest levels since 2005, and recent reports suggest they could fall by an additional percentage point in upcoming weeks.

Treasury Secretary Henry Paulson reportedly is considering a plan that would have lending giants Fannie Mae and Freddie Mac encouraging banks to issue 30-year fixed mortgages at rates as low as 4.5%. No official announcement has been made. Treasury and Freddie Mac officials did not return calls for comment. And a spokeswoman for Fannie Mae declined to comment.

Should the plan materialize, rates would be among the lowest seen in 50 years, says Keith Gumbinger, vice president of HSH Associates, which tracks rates on mortgages and consumer loans. But it’s far too early to count on such a move. "It's all rumor at this point," he says. "They're 'discussing the potential.' There's no plan, no details."

Even without the rumored plan in place, mortgage rates still remain well below those of the past year.

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Rates began to drop last week after the Federal Reserve announced it would purchase $600 billion in mortgage-related debt held by Freddie, Fannie, Ginnie Mae and the Federal Home Loan Banks. Rates have bounced around since but have yet to creep above 6%.

On Wednesday, the national overnight average 30-year, fixed-rate mortgage was 5.70%, up slightly from 5.64% a week earlier but down from 6.33% two weeks ago, according to mortgage tracker Bankrate.com.

Consumers have been quick to take advantage. Mortgage applications jumped 112% last week, while refinancing requests were up an astonishing 203%, according to the Mortgage Bankers Association, an industry group.

While the latest news has some consumers wondering how low rates can go, potential borrowers shouldn't stay in limbo too long. Here's what they should consider:

Prepare to pounce on great rates. Analysts agree: Current rates are very attractive, and they aren't going to rise anytime soon, thanks to government efforts like last week's bailout.

"I don't think the window of opportunity is going to slam shut on anyone," says Gumbinger. That said, rates fluctuate daily based on any number of market factors. Whether you're considering buying or refinancing, pull together your financial paperwork, including federal tax returns, investment records and proof of income, so you can jump on good rates immediately.

Polish your credit score. The almighty credit score is king these days, and, given some of the early details leaked about the Treasury's plan, it will continue to be.

Most likely, the more favorable mortgage rates will be reserved solely for those with the very best credit scores -- at least a 760 on the 300- to 850-point scale, says Cristian de Ritis, a director of credit analytics for Moody's Economy.com, an economic forecaster.

That's all the more reason to build up your credit and avoid mistakes that could trash your score, like late payments and big balances. Help for those with less-than-stellar scores has yet to materialize, although Federal Reserve Chairman Ben Bernanke urged the government last week to take steps to stem foreclosures by buying delinquent mortgages and offering bigger incentives for banks to refinance loans.

Refinance based on rates, not rumors. Early indications are that the Treasury’s low-rate plan would apply only to new mortgages, says Gumbinger. So if you’re looking to refinance, there's no sense in hesitating. Bear in mind, however, that lending standards are still tight. You'll need a great credit score and at least 10% equity in your home to qualify in most markets.

House hunters should stay the course. Don't wait to buy a home based on a government plan that may not materialize, says de Ritis. Even if the plan does go through, those low 4.5% mortgages will be extended only to borrowers who fit the plan criteria and won't be offered to borrowers across the board. If you were already thinking about buying, there's no reason to put off your search.

This article was reported and written for SmartMoney by Kelli B. Grant.