Mortgage refinancing gets tougher

With rates on many homeowners' adjustable-rate mortgages rising, some who would like to refinance into a new loan are finding they can't.

In some cases, that is because their loan carries a prepayment penalty, which would force them to come up with thousands of dollars if they refinance in the first few years. Such penalties are common with so-called option adjustable-rate mortgages, which typically carry a low teaser rate that rises sharply after an introductory period.

Other borrowers are getting caught short by a changing housing market — one in which home prices have flattened and lenders are beginning to tighten their standards after a long period of making mortgages easier and easier to get. The challenges are greatest for homeowners whose credit has declined since they took out their last loan and for those who have little if any equity. Some of these borrowers are still able to refinance but are finding it more costly than they expected.

These new challenges come at a time when many borrowers who took out adjustable-rate mortgages are facing higher payments. There are about $1.1 trillion to $1.5 trillion in ARMs that will face rate increases this year, according to the Mortgage Bankers Association. The MBA expects borrowers to refinance as much as $700 billion of those mortgages.

"The decrease in property values, combined with prepayment penalties, is making it very challenging for people to get out of these loans," says Ed Shanks, an executive vice president with U.S. Bank Home Mortgage, a unit of U.S. Bancorp. U.S. Bank is seeing more loans fall through, particularly in markets such as Arizona, California, Colorado and Ohio, where home values have softened. It could be "the tip of the iceberg," Shanks says. In recent years, many homeowners refinanced repeatedly — to get a better rate, lower their payment, consolidate debt or pull out cash. Even now, mortgage rates remain relatively attractive, though they have moved up from their recent lows in early December, and most borrowers still should be able to take advantage of them.