As Thomas Paine once wrote, these are times that try home buyers' souls.

Well, maybe those weren't his exact words. But today, they might as well be. Mortgage rates have climbed to two-year highs. Sellers can pick and choose from multiple offers. New home prices have jumped to their highest levels ever.

This type of market brings into play financing options home shoppers didn't have to think about when 30-year fixed-rate loans were going for less than 6.5 percent, experts say. And as these extended rate locks, temporary rate buy-downs and convoluted adjustable-rate mortgages become more popular, potential buyers need to look closely at their game plans before they leap into purchases.

"A 30-year fixed-rate program is still an attractive program, but if rates start to trend up more, people will gravitate toward either buying the rate down if they want to stay on the 30-year fixed, or maybe getting a buy-down loan, which is still a fixed-rate loan but is lower the first year or two," says Alan Cohen, a branch manager in Indianapolis with Irwin Mortgage Corp.

That can help get people into homes, he adds, but "any time a program looks too good to be true, you have to make sure you understand all the impact a loan can go through."

Low rates creep higher
It wasn't too long ago that real estate shopping was simple.

From January 1995 through last October, the Bankrate.com national average for 30-year fixed mortgage rates slipped lower and lower before bottoming out at 6.46 percent. During that same time, home prices rose at a steady, but hardly outrageous, low- to mid-single digit annual clip, the unemployment rate fell to a record low and the stock market soared. This Wonderland scenario helped boost the U.S. homeownership rate to an all-time high of 66.8 percent in the third quarter of 1998.

Now, the economic backdrop that made all of this possible shows signs of fraying. Jobs remain plentiful, but the cost of raw materials and labor seems poised to pick up, giving companies a reason to raise prices. That chain reaction has sparked long-dormant fears of inflation, sending the 30-year fixed rate average to 7.5 percent on June 9, its highest level in 22 months. The stock market has taken a beating too, and a Federal Reserve Board rate hike at the end of June or in August could make financing even more expensive.

Finally, there's the issue of housing prices. On June 2, the Commerce Department's Bureau of the Census reported that new single-family homes cost $193,100 on average in April. That was the highest level ever recorded in more than 24 years of data collection.

Prices shooting up
Does all this really matter to the average home hunter? Richard Passmore thinks so.

The 41-year-old telecommunications and computer equipment installation manager started looking for his first house in Salinas, Calif., about 3 months ago. At the time, his mortgage broker said he could get a Federal Housing Administration mortgage with 3 percent down at about 7 percent. The base price of the model he wanted was $173,500, up from $169,000 last year.

Everything seemed on track. But by the time he signed a sales contract, the base price had risen $3,000, and he had to pay even more for a premium lot and upgrades. Because he hadn't locked in a rate earlier, Passmore ended up having to settle for a 7.5 percent mortgage too.

Yet even with that financial hit, he made out better than someone walking in the door in mid-June could. That's because the bare-bones model now goes for $208,000 -- a whopping 23 percent more than it commanded in 1998.

"I was really trying to stall as much as I could with my wife and all so I could save more money," Passmore says. "But I think we made the right move, considering the interest rates are heading up."

As an aside, he adds that things aren't much better in the area for existing home buyers.

"The houses, they've got to be 25 or 30 years old, but people are buying them," he says. "They put a for sale sign out and they're gone."

Shop smarter
In this kind of environment, shoppers have to be smarter than ever. On the financing side, that means getting pre-approved for a mortgage early on, rather than just pre-qualified. With pre-approval, the lender pulls a credit report, verifies a borrower's income and takes other preliminary underwriting steps to come up with a maximum allowable loan amount that usually doesn't change. In a pre-qualification, the customer provides the information, but the lender doesn't check it.

"Pre-approval is important because first of all, it gives you the ease of mind that you're approved to go out and buy a house that you want to get. But it also gives you leverage in the eyes of the sellers," says Louis Cronmiller, a Trustcorp Mortgage Corp. branch manager in South Bend, Ind.

"If your Realtor can say to the seller, 'My buyer is approved,' there is no worry. Your offer, no matter if it's better or worse, carries a lot of weight compared to someone who has not been pre-approved."

At Trustcorp, Cronmiller says someone can get the step behind them by paying just $20 for a credit check. They'll still have to cover the appraisal fee and other closing costs later on the same as any borrower, however.

ARMs have new flavors
With rates and prices climbing, people should consider alternative financing options such as adjustable-rate mortgages, too. That's because ARMs feature lower monthly payments at first, something that might help marginal buyers get into a home, considering the principal and interest payment on a $100,000, 30-year fixed loan had risen to $699 in early June from $629 in October, according to Bankrate.com data.

"When you see interest rates going up, a lot of the adjustable-rate mortgages actually become more affordable at that stage in the game," says Peter Goldberg, senior vice president of Ohio Savings Bank in Cleveland. "Ultimately people look for that lower payment and Arms can really provide a lot of that."

At the Bankrate.com 6.07 percent average rate of June 9, for example, a $100,000 one-year ARM would have monthly payments in the first year of just $604. But consumers should keep in mind that the payment fluctuates with interest rates, usually on an annual basis. They have to be prepared to meet their obligations even if the payment rises substantially 12 months down the road.

Borrowers can limit their exposure by choosing a longer-term ARM, such as a 5/1 or 7/1 that features an initial fixed period of five years or seven years. Yet the payment advantage of such loans shrinks because they have higher initial rates than their one-year counterparts.

Balloon loans are another option available to get a lower payment in the first few years. These mortgages charge less interest up front for a set time frame, but require the borrower to either refinance at the end of that period, pay off the loan or convert it to a fixed payment schedule.

In mid-June, Trustcorp's Cronmiller says a seven-year balloon might go for 6.75 percent. The borrower would make payments of principal and interest and, assuming rates didn't shoot up more than 5 percent in the meantime, pay about $250 to roll the loan into a fixed schedule for the last 23 years.

New home buyers may be able to use builder incentives to their advantage, too. Cohen of Irwin Mortgage notes that companies in his market usually offer a few thousand dollars to consumers to put toward their mortgages. Someone can use that money to buy down the loan rate for a couple years.

"If you have a rate today of 7.5 percent (on a 30-year fixed loan), you might find a buy-down set up where the builder will actually allocate the points, say three points," Cohen says. "If you're doing 5.5 percent the first year, 6.5 percent the second year and 7.5 percent the third year (and thereafter), the lender will hold the funds like a tax and insurance account, and every month they will draw down the difference out of those funds like an escrow."

That would help people who don't have much money now but expect to earn more later. Others who want to have a low rate for good can put the builder's money toward that end. Using the same loan parameters, for instance, somebody could buy the rate down about three-eighths to one-half of a percentage point for the entire 30 years, according to Cohen.

The 'R' word -- rent
Even though financial options such as these make buying easier, today's climate makes some experts go so far as to mention the "R" word -- renting -- as a sensible housing alternative for certain consumers. In super-hot markets, says Ben Coombs, a certified financial planner with Petra Financial Advisers in Three Rivers, Calif., the cost of owning is just too high, especially for people who don't plan to live in the area for long.

"Right now in California, rentals look awfully good as opposed to ownership in the shorter term," says Coombs, who has a son living in the high-priced high-tech mecca, Silicon Valley.

"It's just that you can rent the same house for considerably less than the carrying costs of owning it with the high prices and now the higher interest rates."

Of course, not everyone is ready to throw in the towel. Though rates have come up, lenders say, they still compare favorably with what was available in the 1980s and a good portion of this decade. Buyers who already own homes have seen their equity rise along with the market as well, making them not that much worse off on a relative basis than they were before.

"It's all relative, a rapid increase to a 7-1/2 percent interest rate," says Cathy Whatley, a Realtor who is president of Buck & Buck Inc. in Jacksonville, Fla. "That is still such a wonderful interest rate compared to previous market times, so you just have to keep in perspective that yes, while it's going up, it's still a heck of an opportunity to be able to own a home."

"There are so many positive dynamics in the marketplace," she adds. "It's not just tied with the interest rates and home prices, but consumer confidence, people's comfort with their jobs, low unemployment and there are just so may positive economic indicators that I don't think at this point, people will be backing off."

Coming June 24:

Not everybody wants the mortgage broker to know about that $100,000 in offshore funds. That's why some lenders offer mortgages that require less documentation or even no documentation of income or assets. The loans can also be a good option for the self-employed, first-time buyers and others with odd borrowing requirements.