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Preventing Identity Theft

Unfortunately, it's not possible to prevent identity theft and credit fraud entirely. However, by managing your personal information carefully, and with a full understanding of its importance, you can substantially reduce the likelihood that it will happen to you. The following tips show you how.

How to Outsmart Identity Thieves

Be careful about giving out personal information. Whether on the phone, by mail, or on the Internet, never give anyone your card number, Social Security number, or other personal information for a purpose you don't understand. Ask to use other types of identifiers when possible, and don't carry your SSN card. Be sure to keep it in a secure place.

Protect your mail. To stop a thief from obtaining personal information about you by going through your through trash or recycling bin, tear or shred your charge receipts, credit applications, insurance forms, bank statements, expired charge cards, and preapproved credit offers. Deposit outgoing mail in post office collection boxes or at your local post office. Promptly remove mail from your mailbox after it's delivered. If you plan to go away, call the U.S. Postal Service at 800-275-8777 and request a vacation hold.

Guard your credit cards. Minimize the information and the number of cards you carry in your wallet. If you lose a card, contact the fraud division of the credit card company. If you apply for a new credit card and it doesn't arrive in a reasonable period, contact the issuer. Watch cashiers when you give them your card for a purchase. Also, when you receive a new card, sign it in permanent ink and activate it immediately.

Pay attention to billing cycles. Contact creditors immediately if your bills arrive late. A missing bill could mean an identity thief has taken over your credit card account and changed your billing address.

Safeguard personal information in your home. Especially if you are having service work done in your home, employ outside help, or have a roommate.

Find out who has access to your information at work. Be sure to verify that records are kept in a secure location, and are accessible only to employees who have a legitimate reason to access it.

Be smart about passwords and PINs. Memorize your passwords and personal identification numbers instead of carrying them with you. Avoid using easily available information like your mother's maiden name, your birth date, the last four digits of your SSN or your phone number, or a series of consecutive numbers.

Fraud Alerts. You may place an Initial 90 day Fraud Alert by calling any one of the 3 nationwide credit reporting companies. The agency that accepts your request will share your request with the other two credit reporting companies, which will add the alert to your file or request that you provide them additional information. You will receive a confirmation when an alert is added to your file.

Place a Security Freeze on your credit file. If you reside in select states you have the right to place a security freeze on your Equifax credit file. A security freeze will prevent us from reporting your Equifax credit file to third parties, such as credit grantors and other companies and agencies, except those exempted by law or those for whom you contacted us and requested that we temporarily lift the security freeze.

A security freeze will require you to plan ahead for all your credit applications as you will need to contact us to request that we temporarily lift your freeze to allow us to report your Equifax credit file to the credit grantor you identify. Under the laws of most states, it may take up to three business days to process your request to temporarily lift the security freeze. It may take longer if you have lost the security freeze confirmation number which we provided to you when you first requested the security freeze be placed on your credit file. You may not be able to request a temporary lift of a security freeze during non-business hours or on weekends. A security freeze may hinder your ability to immediately obtain credit to make major purchases. Accordingly, if you are credit active and apply for credit on a regular basis and have a security freeze on your Equifax credit file you need to be especially mindful of the need to plan ahead and contact us in advance to request a temporary lift of the security freeze on your Equifax credit file.

Active Duty Alert. you may request an active duty alert, which will remain on your file for 12 months, by calling any one of the nationwide credit reporting companies. This alert removes your name from pre-screened offers of credit for 2 years. You will receive a confirmation when an alert is added to your credit file.

Sharing of Alerts.The credit reporting company that accepts your request for a Fraud or Active Duty alert will share your request with the other two nationwide credit reporting companies, which will add the alert to your file or request that you provide them additional information.

Other Important Facts

Zero responsibility doesn't mean zero problems. Because credit card companies must limit consumer responsibility to $50 in most cases of fraud, and because many new cards include "zero responsibility" protection, some people think there's no reason to worry about credit fraud. But in its most advanced form -- identity theft -- credit fraud can cause wide-ranging long-term problems. Identity thieves can use your personal information to take over your credit accounts and open new ones. They may even use your good credit to get a job, take out a car loan, or rent an apartment.

Check your credit report regularly. Checking your credit report can help you catch mistakes and fraud before they wreak havoc on your personal finances. Make sure your report is accurate and includes only those activities you've authorized. It's also a good idea to review your credit report from each of the three major credit reporting agencies every year -- it's possible that information is reported to one but not the others.

Did You Know?

Although the problem is nationwide, states with the highest incidence of identity theft are California, New York, New Jersey, Connecticut, Pennsylvania, Ohio, Florida, Georgia, Texas, Illinois, and Washington.

Copyright Equifax 2007

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Coping with Identity Theft:
Reducing the Risk of Fraud

The crime of identity theft

It can happen to anyone. The phone rings and a collection agency demands that you pay past-due accounts for goods you never ordered. The supermarket refuses your checks because you have a history of bouncing them. But you have always paid bills on time. What has happened?

The crime of identity theft is on the rise. Recent surveys show there are currently about 9 million victims each year. Using a variety of methods, criminals steal Social Security numbers, driver's licenses, credit card numbers, ATM cards, telephone calling cards, and other pieces of individuals' identities such as date of birth. They use this information to impersonate their victims, spending as much money as they can in as short a time as possible before moving on to someone else's name and identifying information.

There are two types of identity theft.

  • "Account takeover" occurs when a thief acquires your existing credit account information and purchases products and services using either the actual credit card or simply the account number and expiration date.
  • "Application fraud" is what some experts call "true name fraud." The thief uses your SSN and other identifying information to open new accounts in your name. Victims are not likely to learn of application fraud for some time, because the monthly account statements are mailed to an address used by the imposter. In contrast, victims learn of account takeover when they receive their monthly account statement. This guide discusses strategies for reducing the risk of both types of fraud.

Generally, victims of credit card fraud are liable for no more than the first $50 of the loss. (Truth in Lending Act, Fair Credit Billing Act, 15 USC sec. 1601) In most cases, the victim will not be required to pay any part of the loss. But debit card users have less protection against fraud. Not only are individuals' checking accounts wiped out, debit card users could be liable for the total amount of the loss depending on how quickly they report the loss to the financial institution.

Even though victims are usually not saddled with paying their imposters' bills, they are often left with a bad credit report and must spend months and even years regaining their financial health. In the meantime, they have difficulty getting credit, obtaining loans, renting apartments, and even getting hired. Victims of identity theft find little help from the authorities as they attempt to untangle the web of deception that has allowed another person to impersonate them.

Stealing wallets used to be the best way identity thieves obtained SSNs, driver's licenses, credit card numbers and other pieces of identification. While still employed, identity thieves now use a variety of means:

  • "Dumpster diving" in trash bins for unshredded credit card and loan applications and documents containing SSNs.
  • Stealing mail from unlocked mailboxes to obtain newly issued credit cards, credit card statements, pre-approved credit offers, investment reports, insurance statements, benefits documents, or tax information. Unfortunately, even locked mailboxes may not stop the most determined thief.
  • Accessing your credit report fraudulently, for example, by posing as an employer, loan officer, or landlord.
  • Obtaining names and SSNs from personnel or customer files in the workplace.
  • "Shoulder surfing" at ATM machines and phone booths in order to capture PIN numbers.
  • Finding identifying information on Internet sources, via public records sites and fee-based information broker sites.

Take these steps to reduce your risk of becoming a victim of identity theft:
Credit cards, debit cards, and credit reports:

  1. Reduce the number of credit and debit cards you carry in your wallet. Carry one or two credit cards and your ATM card in your wallet. If you have a debit card, take advantage of online access to your checking account to monitor account activity frequently. Report evidence of fraud to your financial institution immediately.
  2. When using your credit and debit cards at restaurants and stores, pay close attention to how the magnetic stripe information is swiped by the waiter or clerk. Dishonest employees have been known to use small hand-held devices called skimmers to quickly swipe the card and then later download the account number data onto a personal computer. The thief uses the account data for Internet shopping and/or the creation of counterfeit cards.
  3. Do not use debit cards when shopping online. Use a credit card because you are better protected in case of fraud.
  4. Keep a list or photocopy of all your credit cards, debit cards, financial accounts, and investments -- the account numbers, expiration dates and telephone numbers of the customer service and fraud departments -- in a secure place (not your wallet or purse) so you can quickly contact these companies in case your credit cards have been stolen or accounts are being used fraudulently.
  5. Never give out your SSN, credit or debit card number or other personal information over the phone, by mail, or on the Internet unless you have a trusted business relationship with the company and you have initiated the call. Identity thieves have been known to call their victims with a fake story that goes something like this. "Today is your lucky day! You have been chosen by the Publishers Consolidated Sweepstakes to receive a free trip to the Bahamas. All we need is your Social Security number, credit card number and expiration date to verify you as the lucky winner."
  6. Always take credit card receipts with you. Never toss them in a public trash container. When shopping, put receipts in your wallet rather than in the shopping bag.
  7. Never permit your credit card number to be written onto your checks. It's a violation of California law (Civil Code sec. 1725) and laws in many other states, and puts you at risk for fraud.
  8. Watch the mail when you expect a new or reissued credit card to arrive. Contact the issuer if the card does not arrive.
  9. Order your credit report at least once a year. Federal law gives you the right to one free credit report each year from the three credit bureaus: Equifax, Experian, and TransUnion. If you are a victim of identity theft, your credit report will contain the tell-tale signs – inquiries that were not generated by you, as well as credit accounts that you did not open. The earlier you detect fraud, the easier and quicker it will be to clean up your credit files and regain your financial health.

    Passwords and PINS:
  10. When creating passwords and PINs (personal identification numbers), do not use the last four digits of your Social Security number, mother's mother's maiden name, your birthdate, middle name, pet's name, consecutive numbers or anything else that could easily be discovered by thieves. It's It's best to create passwords that combine letters and numbers.
    Here's a tip to create a password that is strong and easy to remember. Think of a favorite line of poetry, like “Mary had a little lamb.” Use the first or last letters to create a password. Use numbers to make it stronger. For example, MHALL, or better yet MHA2L!. The longer the string, the harder it is to crack.
  11. Memorize all your passwords. Don't record them on anything in your wallet.
  12. Shield your hand when using a bank ATM machine or making long distance phone calls with your phone card. "Shoulder surfers" may be nearby with binoculars or video camera.

    Social Security numbers:
  13. Protect your Social Security number (SSN). Release it only when absolutely necessary (like tax forms, employment records, most banking, stock and property transactions). The SSN is the key to your credit and financial accounts and is the prime target of criminals.
    If a business requests your SSN, ask if it has an alternative number that can be used instead. Speak to a manager or supervisor if your request is not honored. Ask to see the company's written policy on SSNs. If necessary, take your business elsewhere. If the SSN is requested by a government agency, look for the Privacy Act notice. This will tell you if your SSN is required, what will be done with it, and what happens if you refuse to provide it. If your state uses your SSN as your driver's license number, ask to substitute another number.
  14. Do not have your SSN or driver's license number printed on your checks. Don't let merchants hand-write the SSN onto your checks because of the risk of fraud.
  15. Do not say your SSN out loud when you are in a public place. And do not let merchants, health care providers, or others say your SSN out loud. Whisper or write it down on a piece of paper instead. Be sure to retrieve and shred that paper.
  16. Examine your Social Security Personal Earnings and Benefits Estimate Statement each year to check for fraud. The Social Security Administration mails it to adult-age SSN holders about three months before the birthday.
  17. Do not carry your SSN card in your wallet except for situations when it is required, the first day on the job, for example. If possible, do not carry wallet cards that display the SSN, such as insurance cards, except when needed to receive healthcare services.
    If you feel you must carry your health insurance or Medicare card with you at all times, try this. Photocopy the card and cut it down to wallet size. Then remove or cut out the last four digits of the SSN. Carry that with you rather than the actual card. But be sure to carry your original Medicare card with you the first time you visit your healthcare provider. They are likely to want to make a photocopy of it for their files.
  18. If you live in a state that uses the SSN as the driver's license number, we recommend that you contact your Department of Motor Vehicles and request a different number.

    Internet and computer safeguards:
  19. Install a firewall on your home computer to prevent hackers from obtaining personal identifying and financial data from your hard drive. This is especially important if you connect to the Internet by DSL or cable modem.
  20. Install and update virus protection software to prevent a worm or virus from causing your computer to send out files or other stored information.
  21. Password-protect files that contain sensitive personal data, such as financial account information. Create passwords that combine 6-8 numbers and letters, upper and lower case. In addition, encrypt sensitive files.
  22. When shopping online, do business with companies that provide transaction security protection, and that have strong privacy and security policies.
  23. Before disposing of your computer, remove data by using a strong “wipe” utility program. Do not rely on the “delete” function to remove files containing sensitive information.
  24. Never respond to "phishing" email messages. These appear to be from your financial institution, eBay, or PayPal. They instruct you to visit their web site, which looks just like the real thing. There, you are told to confirm your account information, provide your SSN, date of birth and other personal information. Legitimate financial companies never email their customers with such requests. These messages are the work of fraudsters attempting to obtain personal information in order to commit identity theft.
  25. Be aware that file-sharing and file-swapping programs expose your computer to illegitimate access by hackers and fraudsters. If you use such programs, make sure you comply with the law and know what you are doing. Install and update strong firewall and virus protection.
    Many file-sharing programs are downloaded by youngsters without the knowledge of their parents. There are software programs available that identify file sharing software and locate shared files on home computers.

    Reducing access to your personal data:
  26. To minimize the amount of information a thief can steal, do not carry extra credit cards, debit cards, your Social Security card, birth certificate or passport in your wallet or purse, except when needed. At work, store your wallet in a safe place.
  27. If possible, do not carry other cards in your wallet that contain the Social Security number (SSN), except on days when you need them.
  28. Install a locked mailbox at your residence to deter mail theft. Or use a post office box or a commercial mailbox service. When you are away from home for an extended time, have your mail held at the Post Office, or ask a trusted neighbor to pick it up.
  29. When ordering new checks, pick them up at the bank. Don't have them mailed to your home. If you have a post office box, use that address on your checks rather than your home address so thieves will not know where you live.
  30. When you pay bills, do not leave the envelopes containing your checks at your mailbox for the postal carrier to pick up, or in open boxes at the receptionist's desk in your workplace. If stolen, your checks can be altered and then cashed by the imposter. It is best to mail bills and other sensitive items at the drop boxes inside the post office rather than neighborhood drop boxes. If you use a neighborhood drop box, always deposit the mail before the last pick-up of the day.

    Responsible information handling:
  31. Each month, carefully review your credit card, bank and phone statements, including cellular phone bills, for unauthorized use
  32. Convert as much bill-paying as you can to automatic deductions from your checking account and/or credit account Consider using the Internet for banking and paying bills. With fewer account statements and bills mailed to your home, you will reduce the risk of mail theft and identity theft.
  33. Do not toss pre-approved credit offers in your trash or recycling bin without first tearing them into very small pieces or shredding them with a cross-cut shredder. They can be used by "dumpster divers" to order credit cards in your name and mail them to their address. Do the same with other sensitive information like credit card receipts, phone bills, financial account statements, investment account reports, and so on. Home shredders can be purchased in many office supply stores. We recommend cross-cut shredders.
  34. Use a gel pen for writing checks. Experts say that gel ink contains tiny particles of color that are trapped in the paper, making check washing more difficult .
  35. Demand that financial institutions adequately safeguard your data. Discourage your bank from using the last four digits of the SSN as the PIN number they assign to customers. If you have been given the last four SSN digits as a default PIN, change it to something else. Insist they destroy paper and magnetic records before discarding them. By not adopting responsible information-handling practices, they put their customers at risk for fraud.
  36. When you fill out loan or credit applications, find out how the company disposes of them. If you are not convinced that they store them in locked files and/or shred them, take your business elsewhere. Some auto dealerships, department stores, car rental agencies, and video stores have been known to be careless with customer applications. When you pay by credit card, ask the business how it stores and disposes of the forms. Avoid paying by credit card if you think the business is not careful. When paying with credit cards on the Internet, be sure the company uses secure transmission and storage methods
  37. Store canceled checks in a safe place. In the wrong hands, they could reveal a lot of information about you, including the account number, your phone number and driver's license number. If you rent a storage locker, take extra precautions when storing cancelled checks, tax return information, and other sensitive financial information. Storage lockers are popular targets for robbers.
  38. Store personal information securely in your home, especially if you have roommates, employ outside help, or have service work done in your home. Use a locking file cabinet or safe.
  39. Any entity that handles personal information should train all its employees, from top to bottom, on responsible information-handling practices. Persuade the companies, government agencies, and nonprofit agencies with which you are associated to adopt privacy policies and conduct privacy training

For More Information

Credit Reporting Agencies

Federal Trade Commission Identity Theft Clearinghouse

Copyright © 1995-2006.
Privacy Rights Clearinghouse / UCAN

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Keep the mortgage or pay off the house?

Mortgage burnings used to be a ritual that families hoped to be lucky enough to perform. But times have changed. Now, growing older and retiring still includes another ritual: paying monthly on a mortgage.

As they head down the road toward retirement, many people are asking themselves: Should I use part of my nest egg to pay off the mortgage and gain a sense of security? Or should I leave my nest egg intact where it's earning interest and let my mortgage continue to provide me with a tax deduction?

If you decide to keep your mortgage in retirement, you won't be alone.

In 2004, 32 percent of households headed by someone age 65 to 74 were carrying home mortgage debt, and nearly 20 percent of households headed by those 75 and older had a mortgage, according to the triennial Federal Reserve Survey of Consumer Finances conducted in 2004.

About 25 percent of those of any age who considered themselves retired had a mortgage.

Is carrying a mortgage into the sunset something most people should seek to avoid? Or does holding onto a mortgage make financial sense, especially when rates are low and it is possible to earn a large enough return on money invested to pay the mortgage and still have a significant gain

The answer isn't a slam-dunk. The right decision depends wholly on your personal financial situation.

Your mortgage's tax benefit

An income tax deduction for homeownership is sacred in Americans' minds, but often the deduction doesn't add up to much. The financial advisers who tout its value probably live in expensive areas and own pricey houses, while the rest of us aren't so lucky.

Sure, mortgage interest and property taxes are tax-deductible, but the amount of interest and taxes typically paid on a median-priced home in the U.S. results in unimpressive tax benefits. If you live in the Midwest, are in the 25 percent tax bracket and you have 20 percent equity in your median-priced home, there are possibly no tax benefits at all.

Uncle Sam's standard deduction of $10,700 in 2007 for a married couple filing jointly -- available whether you own a home or not -- exceeds the value of the mortgage interest and tax deductions from the very first day of homeownership.

In September, the national median home sales price was $224,900. With a 20 percent equity stake and a 30-year mortgage loan at 6 percent, in the first year, the tax benefit is an estimated $1,246. The value of the deduction declines every year, until it disappears altogether in the 13th year of the mortgage.

In lower-priced areas, it gets worse. Married taxpayers in Akron, Ohio, who own a regional median-price house worth $118,200, mortgaged with 20 percent equity, and who are in the 25 percent tax bracket would receive zero tax benefits from day one.

The picture changes dramatically for a single homeowner with a house in San Francisco, where the median price is $749,400. In the first year of a home purchase, for which he puts down 3 percent, the tax benefit would be worth $16,222. If that homeowner in the 33 percent tax bracket were to hold on to his home for 30 years, the cumulative deduction would be worth $368,728. A pretty good deal.

Analyze your own situation using Dallas Morning News reporter Scott Burns' calculator. You may find that paying off your mortgage is a very smart tax move, since you get the standard deduction no matter what.

Social Security and taxes

If, after retirement, you will be relying on a mix of Social Security and savings from an IRA or 401(k) for income, reducing the number of pretax dollars you have to spend is startlingly important.

Social Security benefits become taxable for a married couple filing jointly when one-half of their total Social Security benefit added to all their other income is greater than $32,000 -- or $25,000 for a single individual.

In 2006, a couple getting the average Social Security benefit received $19,896. Half of that is $9,948. That means they can withdraw $20,100 from tax-advantaged savings for a total income of $40,000 and pay few, if any, federal taxes at all, in part because Social Security remains tax free and the couple gets extra standard deductions for being older than 65.

In many parts of the country that's a comfortable income -- particularly for people who own their home free and clear. Add a mortgage to the equation and the picture changes significantly.

If this couple has a monthly $1,000 mortgage payment and opts to pay it by pulling savings out of a 401(k) or other tax-advantaged account, they'll not only pay taxes on Social Security, they'll also be taxed on the money they withdraw from their 401(k). Altogether, they would need to withdraw $39,000 from the account to cover the extra mortgage payments and taxes, which increases their tax bill from nearly zero to about $4,000.

If this couple, who could otherwise live comfortably on $40,000, happens to withdraw another $6,000 from their 401(k)s for a total of $45,000, then their taxable Social Security and income will likely push them into the 25-percent tax bracket, raising what they'll pay in taxes to about $5,700.

"Between Social Security and an untaxed nest egg, people are thrown into a position where all of their withdrawals and the majority of their Social Security is taxable. The longer people can defer touching their untaxed nest egg, the better off they are," says Sheryl Garrett, founder of the Garrett Planning Network, based in Shawnee Mission, Kansas.

Don't mess with your 401(k)

If, in order to pay off your mortgage, you have to reduce or stop contributing to your 401(k), you're likely not making a good decision.

In a recent research report, economists posed this question: "If I have extra money for savings, should it go toward retirement or paying down my mortgage?"

They examined the tax advantages of itemizing deductions, typical mortgage rates and savings interest rates on retirement accounts. After analyzing those variables, the economists concluded, "About 38 percent of U.S. households that are accelerating their mortgage payments instead of saving in tax-deferred accounts are making the wrong choice."

One of three authors of the report, Clemens Sialm, an assistant professor of finance at the University of Michigan, says his conclusions are actually more dramatic than they appear. He says the number of people who should be saving instead of paying off the mortgage is closer to 60 percent because the economists relied on very conservative investment returns to calculate their findings and didn't take into account employer matches.

Sialm says anyone with an employer match who is accelerating payment on his mortgage at the expense of maxing out his tax-advantaged retirement account is almost certainly making a mistake.

"The typical match is 50 percent of the first 6 percent saved. That means if you save 6 percent of income, you get 3 percent additional saving, effectively a 50 percent return on your investment. Forgoing that is a costly mistake," Sialm says.

Don't mess with your 401(k), part II

Taking out a lump sum from your 401(k) to pay off a mortgage is a particularly bad idea.

A couple with $50,000 in taxable income who pulls $100,000 out of their 401(k) plans to pay off the mortgage plus enough to pay off the additional taxes will reduce their 401(k) savings by at least $135,000. That's assuming they are older than 59½ so there are no penalties.

Withdrawing from a retirement plan to pay down a mortgage when the retirement plan is 100 percent taxable upon distribution is a lousy idea, says Robert Fragasso, president of The Fragasso Group in Pittsburgh.

"That money is taxed at the individual's highest bracket. You're paying an exorbitant cost to free up money."

The pros of paying off your mortgage

All that said, it's not a bad idea to pay off your mortgage prematurely. If you can swing adding an extra payment every month toward the principal without sacrificing your retirement savings, that might be the ideal approach.

You can get more from a reverse mortgage. If a reverse mortgage is your financial fallback position and you owe money on the property, you must take at least that amount as a lump sum advance at closing and use it to pay off your debt at that time. Therefore, having a paid-off mortgage increases the amount of cash available to you in a single lump sum, credit line or monthly advance.

You leave more to your heirs. If you want to leave the house to your children or someone else who doesn't have a lot of resources, do them a favor and pay off the mortgage. Otherwise, they maybe faced with selling the house whether they want to or not.

You protect yourself from suit. In many states, if you're sued, your home is exempt from judgment. Owning your home outright also can provide some protection from bankruptcy. "One hopes sheltering assets in your home will never pay off, but it's something to consider," says Garrett.

Make a sure bet. Gillette Edmunds, author of "Retire on the House," a book about real estate investing, pooh-poohs the notion that it is smarter to keep a mortgage and invest at a higher interest rate. "The problem is that mortgage interest is a sure thing and the investment isn't," he says. "You could lose everything you invested and still have to pay the mortgage."

Peace of mind. For many people, paying off the mortgage has intangible advantages. "You would never believe how fabulous and freeing it feels to pay off a mortgage," Garrett says. "The psychological benefits are enormous."

This article was reported and written by Jennie L. Phipps for Bankrate.com.

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Expect a home refinancing boom in '07

With interest rates likely to keep rising, many homeowners will look to get out of adjustable loans -- unless they now owe more than their houses are worth.

2007 will bring an unusual refinancing boom as hundreds of thousands of borrowers bail out of their adjustable-rate home mortgages while the getting is good.

On top of that, sellers and buyers will grapple with stagnant or falling house prices in some markets. And it's anyone's guess what course the Federal Reserve Board will take.

Like the twin strands of a DNA helix, house prices are intertwined with the fate of adjustable-rate mortgages, or ARMs. That's especially true for two types of adjustables: interest-only mortgages and a subset called pay-option ARMs. The main appeal of these nontraditional mortgages is that they have extra-low monthly payments, allowing people to buy more house than they otherwise could afford. That benefit brings a trade-off: Borrowers build up equity slowly or, in some cases, actually lose equity in the house with every monthly payment.

In a self-reinforcing cycle, rapidly rising house prices pushed buyers into getting pay-option and interest-only ARMs, while the popularity of these loans sent house prices even higher. Definitive estimates of the popularity of nontraditional mortgages are hard to come by, but it is believed that in some markets, especially in coastal California, around half or even more of new-home buyers took out interest-only or pay-option ARMs in 2005 and 2006.

Minimum payment might not cover interest

Although nontraditional mortgages start out with low monthly payments, they are sensitive to rising interest rates. A pay-option ARM might have an initial rate of 1.9% that lasts only a month. The rate can rise every month thereafter and could exceed 7% within six or seven months. The sneaky thing about pay-option ARMs is that, although the rate might rise every month, the minimum monthly payment doesn't. The minimum monthly payment changes just once a year. That means that the minimum payment often doesn't even cover the interest charged, so that the loan balance rises.

Expecting to pay off a mortgage that way is like eating a dozen doughnuts every morning and expecting to lose weight by walking a mile every evening.

Mortgage bankers believe a steady influx of homeowners will refinance their nontraditional mortgages into something less exotic in 2007. A lot of them will refinance into 30-year, fixed-rate mortgages. Others will get hybrid ARMs, such as the 5/1 ARM, which has a relatively low introductory rate that lasts for five years, then adjusts annually thereafter. Hybrid ARMs are popular among people who expect to sell their houses within a few years.

Median house prices began falling on a year-over-year basis in the fall, and the National Association of Realtors predicts that falling prices will persist into January and maybe February "before gaining positive traction," as an association news release puts it.

"Our sense is that home sales may have reached a low in August," says the Realtors' chief economist, David Lereah, adding that he expects the pool of unsold houses to shrink early in 2007 "to the point where home prices will rise, but at a slower pace than historical norms."

Such a real estate environment is called a buyer's market because the buyers call the shots. The buyer's market is going to present a big problem in 2007 for those unfortunate souls who have nontraditional mortgages with rising rates. The combination of falling house values and rising loan balances can make it impossible to refinance -- because you can't get a loan for more than the house is worth -- and hard to sell because the lender will demand the full loan amount, even if the selling prices minus real estate commissions and other costs comes out to less than the loan balance.

On top of all this, the Federal Reserve's course in 2007 is more unpredictable than usual. In 2004, everyone knew the Fed was going to start raising rates. In 2005, everyone knew the Fed was going to keep raising rates. In 2006, everyone knew that the Fed was going to stop raising rates. There is no consensus as to what the Fed will do in 2007 -- whether it will start cutting short-term rates, hold rates steady or raise them a couple of more times.

Most economists predict that long-term mortgage rates will rise gradually through 2007. The same economists predicted a similar yearlong rise in 2006 and were caught by surprise when rates on 30-year mortgages fell more than half a percentage point over the summer.

The big questions for 2007

What's going to happen to mortgage rates? No one can predict the movement of interest rates accurately. It's relatively safe to predict that rates will rise in 2007, but no one knows how far they will rise and whether the increase will be slow and steady through the year or whether most of the increase will take place in just a few months, with rates being relatively flat the rest of the year.

And the pundits could be wrong -- rates could fall in 2007.

So, should I refinance in 2007? The answer to that depends on many factors. If you want to refinance strictly to get a lower interest rate, you're probably better off doing it sooner rather than later.

There are other reasons to refinance. Some people refinance to get rid of mortgage insurance. Others do it to pay off high-rate home-equity lines of credit and consolidate all that debt into one mortgage loan. Still others look at refinancing as a way to escape rising interest rates on adjustable-rate mortgages, particularly on interest-only and pay-option ARMs.

If you decide to refinance for one of the above reasons, discuss it with a trusted loan officer or mortgage broker to make sure you have all the facts you need. You might find, for example, that it costs more in the long run (but less in the short run) to consolidate all your debt into one mortgage.

Then when should I refinance? Refinance your mortgage when you're ready to do it. In other words, if it makes financial sense to refinance at a certain time, go ahead and do it. Don't wait for rates to fall further. You can't know if you grabbed the rock-bottom rate until after the fact, so don't even try.

When it comes to mortgages, getting a good rate is good enough. The world won't end if you don't get the absolute best rate.

Should I wait before I buy a house? Waiting for home prices to hit bottom is just like waiting for interest rates to reach their nadir. You can't count on timing the market correctly. When you find the right house at an acceptable price, go ahead and get it. If house values in the neighborhood fall after that, well, you didn't buy the house just to sell it a few months later, right? The house is almost assured of appreciating over the next few years, even if its value falls for a while at first.

This article was reported and written by Holden Lewis for Bankrate.com.

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'07 realty outlook bleak with bright spots

Home prices, appreciation expected to fall, but long-term outlook hopeful

Americans are increasingly nervous about the real estate market in 2007. They have good reason to be. But the news isn't all bad: Interest rates will remain at historically low levels, home buyers will see more opportunities, and best of all, for those planning for the long term, 2009 could be primed for a comeback.

To gauge what the next 12 months might look like, though, BusinessWeek.com asked economists at leading real estate research firms to provide their outlooks for the housing market in 2007. The less-than-festive consensus: Home prices will continue to fall in some markets, and the rate of price appreciation will slow in most places. Declines in homes sales, which directly influence price trends, will set the stage for another year of price decreases in 2008. Foreclosures will continue to increase. For those struggling to hold onto their homes, their net worth will shrink as these homes lose value. Long-term mortgage rates will rise. Housing starts will see double-digit depreciation, the sharpest decline since 1991, the worst year for housing starts on record.

Grim as that might sound, there are some bright spots. Nationwide, home prices will be flat to up slightly in 2007, with many large markets seeing small increases. While new home sales will be down for the year, existing home sales will also be flat. And housing starts won't see as sharp a decline as they did in the early '90s or early '80s.

Another reason for optimism (keeping in mind that expectations are somewhat lower this year): For many, the ongoing market correction will make the dream of buying a home a reality.

“In so many of these markets, housing became extremely unaffordable,” says David Stiff, chief economist at Brookfield, Wis.-based financial data processor Fiserv Lending Solutions, who expects average U.S. home prices to appreciate only 0.1 percent overall in 2007. “Prices moving back in line with household income sets the stage for price appreciation in the future.”

Blame the rapid run-up in prices on speculation. Taking advantage of low interest rates and good economic conditions, investors drove prices to new heights in the first half of the decade, so they could flip purchases for profit. Some markets saw price appreciation rates of as much as 50 percent, versus the average annual rate of about 10 percent.

But as interest rates rose and the gap between income and housing costs widened, home buyers never materialized as expected. Investors have now been forced to dump their property on the market, flooding many places with homes for sale and forcing prices to a more realistic level.

“The market was in a frenzy in 2005,” says Lawrence Yun, senior economist at the National Association of Realtors. “The current transition is just cleansing away the speculators.” Yun expects existing home sales to slip just 0.6 percent in 2007, with a pickup in the fourth quarter continuing into 2008.

Home price trends tend to lag nine to 12 months behind sales trends, said Stiff, who predicts prices will be weakest in 2008 and rebound in 2009.

The researchers at Fiserv arrive at their price forecasts by first estimating what home prices would be if housing supply and demand were in balance — that is, if price levels were consistent with local demographic trends and household-income levels. They then look at the difference between the estimated “equilibrium” price and the actual price level. If prices are too high relative to the affordable, equilibrium level, the forecast is weaker price appreciation. If prices are much higher than equilibrium, the model forecasts price declines.

This explains why former red-hot markets like Southern California, Florida and Las Vegas, which saw the most rapid run-up in prices between 2001 and 2005, will see the sharpest declines in prices in 2007. The Miami area, with an estimated decline of 9.16 percent, will have the second-worst 2007 price drop out of all the country's metro areas. Las Vegas comes in third-worst overall, with a 9.15 percent forecast decline, and Los Angeles, with a 7.1 percent decline, isn't far behind.

Texas didn't experience dramatic price appreciation until more recently. Consequently, the Dallas and Houston metro areas are expected to have 2007 price increases of 4 percent and 3.3 percent.

Since trends in housing starts echo price movement, it goes without saying that new home construction is headed for a major slump in 2007. Nationally, total housing starts will slide 13.2 percent to 1.576 million, according to the National Association of Home Builders in Washington. The last time the nation saw a downturn of this magnitude was in 1991, when starts dropped 15 percent year-over-year.

“It isn't as bad, but it's a very big decline, and one of the big reasons is because of all the investors and speculators,” says Gopal Ahluwalia, vice president of research at the homebuilders association. In the fourth quarter, the seasonally adjusted annual rate will pick up to 1.635 million. At this point, the surplus in inventory will be gone, and prices will start to stabilize, Ahluwalia adds.

As with prices and sales, trends in new home construction can vary dramatically from market to market. Housing starts in the Detroit area will be among the lowest in the country in 2007, plummeting 18.3 percent due to continuing economic woes. Interestingly, prices will not decline, but this is largely because they cannot go any lower. Seattle is the only area that will see a rise (4.7 percent) in housing starts, primarily because of a strong job market with companies like Microsoft and Boeing based in the area.

Ironically, even record-low new home construction numbers can be interpreted as good news for the overall housing market. With fewer homes being built, the market will be forced to absorb its current oversupply, bringing about the supply-demand balance that, once again, leads to more realistic prices.

“It's important to note that the value of homes isn't dropping,” says Santo Rizzo, chief executive of Rizzo Realty Group, a Chicago-based national real estate investment firm.

The normalizing market is causing “unnecessary fear” and creating a favorable market for real estate investors, says Rizzo, who recommends investing for the long term in 2007 “losers” Phoenix, Las Vegas and Orlando, Fla., for their stable economies, high resale marketability, vacation market statuses, low vacancy rates and favorable price-to-income ratios.

Interest rates are, of course, the wild card here. The Mortgage Bankers Association of America expects the Federal Funds Rate — the interest rate on overnight loans between banks — to remain at 5.3 percent throughout 2007, with the average 30-year fixed mortgage rate climbing to 6.6 percent from 6 percent and the one-year adjustable mortgage rate average staying about the same at 5.8 percent. According to the National Association of Realtors, the Fed Funds Rate will fall to 4.8 percent by the end of 2007, the 30-year fixed rate will hit 6.7 percent, and the one-year adjustable rate will decline to 5.5 percent.

But no matter how you spin it, interest and mortgage rates are and will remain at historically low levels. The rest of the economy isn't in terrible shape either — the unemployment rate hovers around a relatively low 5 percent, and the stock market is in the midst of an encouraging rally.

“The law of supply and demand, more than anything, is going to be the driving force that keeps the market relatively ‘flat,’ throughout the year,” says Rizzo. “Since we expect the economy to continue to improve, rents to continue to rise, interest rates to remain relatively low, and investor supplies to be absorbed, the 2007 ‘flat’ market will set the stage for brighter predictions in 2008.”

So while 2007 won't be an outstanding year for real estate, it's unlikely to go down in history as one of the worst. At the very least, it will create an investment opportunity — and a great lesson in basic economics.

This article was reported and written by Maya Roney for Business Week Online.
Copyright © 2007 The McGraw-Hill Companies Inc. All rights reserved.

© 2007 MSNBC.com

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