The Obama administration on Wednesday moved to allow more underwater borrowers to take advantage of lower interest rates under its program to combat the foreclosure crisis.

Strapped borrowers with mortgages worth up to 125% of their home's value will now be eligible to refinance under the program, as long as they are not behind on their payments. Currently, the program caps eligibility at a loan-to-value ratio of 105%.

In addition, mortgage finance companies Fannie Mae (FNM) and Freddie Mac (FRE) said they would offer incentives to lenders to encourage certain underwater borrowers with 30-year fixed-rate mortgages to refinance into shorter-term loans.

Department of Housing and Urban Development Secretary Shaun Donovan announced the new higher loan-to-value limit while touring a foreclosure-ridden neighborhood of Las Vegas, Nev. with Senate Majority Leader Harry Reid, D-Nev., and Rep. Dina Titus, D-Nev.

The move is aimed at helping homeowners who have been unable to refinance into lower-rate mortgages because their homes have plummeted in value. But the effort could be hampered by rising mortgage rates.

"By expanding refinance eligibility, we can bring relief to more struggling homeowners more quickly. It's a crucial step in our broader efforts to get America's housing market and economy on the path to recovery," Treasury Secretary Timothy Geithner said in a statement.

Fannie Mae said it would offer a 0.50% price reduction on charges to lenders for loans with a loan-to-value ratio above 105% and terms of 20 and 25 years.

Freddie Mac said it would limit unspecified special pricing to 25-year loans that are refinanced through the administration's program. The mortgages must also have a loan-to-value ratios between 105% and 125%, the company said.

In a statement, the companies' regulator, Federal Housing Finance Director James B. Lockhart, said borrowers who switch to shorter-term loans would be able to rebuild equity in their homes more quickly. Borrowers who qualify for such loans would save interest costs over the life of the mortgage, but would also see their monthly payments increase.

The refinancing program is a prong of the administration's effort to help borrowers stay in their homes. The program targets underwater borrowers with mortgages backed by Fannie and Freddie. Meanwhile, a separate program of borrower and lender incentives is aimed at helping homeowners who are behind on their payments or at risk of default.

Fannie and Freddie normally require mortgage insurance for loans greater than 80% of the home's value. But under the refinancing program, borrowers with mortgages worth 80% to 125% of their home's value can refinance without having getting mortgage insurance or purchasing additional coverage.

In a speech last month, James B. Lockhart, the regulator for Fannie Mae and Freddie Mac, said that 80,000 people had already refinanced under the program.

However, rising rates could hamper the program's reach. Refinancing volume has dropped off sharply since April, when the average rate on a 30-year fixed-rate mortgage hit 4.78%, according to Freddie Mac (FRE)'s weekly survey of its lenders. The average rate on a 30-year mortgage was 5.42% last week.

Fannie Mae said it would begin accepting for delivery the expanded loan-to-value mortgages on Sept. 1.

Freddie Mac said it would begin immediately accepting the higher LTV mortgages for borrowers refinancing through their current servicer. For borrowers applying through a Freddie Mac-affiliated lender, the higher caps would become available Oct. 1.

-By Jessica Holzer, Dow Jones Newswires; 202-862-9228; jessica.holzer@dowjones.com