The Home Equity ATM Machine Slows in First Half of 2008

Whatever else is going on in the housing market, it appears that Americans are no longer using their homes as gigantic credit cards to finance new cars, tuition, and vacations.

Freddie Mac's report on cash-out refinancing for the first half of 2008 showed that the number of homeowners taking that option was the lowest in three years.

Still, a substantial number of those refinancing Freddie Mac-owned loans � approximately 66 percent � did so with new loans that were at least five percent higher than the loans they replaced. During the first quarter of 2008 the cash-out share was 58 percent. The two quarters, taken together, marked the lowest rate of cash-out refinancing since the autumn and winter of 2004-2005.

According to Amy Crews Cutts, Freddie Mac deputy chief economist, American's pulled out $68 billion in home equity during the first two quarters, $38 billion of it during the second half of that period. The latter amount is less than half the $79 billion cashed out during the second quarter of 2007.

Cash-out refinancing has been largely credited for the ability of homeowners to maintain a high level of consumer spending over the last few years, even as debt rose and wages stagnated.

The figures probably do not indicate a new level of financial responsibility on the part of homeowners. According to Frank Nothaft, Freddie Mac vice president and chief economist, "Declining home values across much of the nation have curtailed the amount of home equity available to be cashed out by homeowners."

Indeed, 9 percent of homeowners who refinanced during the period, probably with the goal of securing a lower interest rate or a fixed-rate mortgage, actually reduced their loan amount, either because they wanted to or because cautious lenders required a lower loan-to-value ratio. This was the largest cash-in share since the second quarter of 2005.

Nothaft said, "Homeowners benefited from the low level of mortgage rates that prevailed for much of the second quarter. On average, homeowners who refinanced during the second quarter lowered their coupon rate by about one-half of a percentage point. In the second quarter of 2008, the median ratio of new-to-old interest rate was 0.93. In other words, one-half of those borrowers who paid off their original loan and took out a new one decreased their first-mortgage coupon rate by about 7.5 percent.

"Homeowners who refinanced last quarter had kept their previous loan for nearly three and a quarter years � about 10 months longer than loans refinanced in the first quarter. This means that many loans refinanced last quarter had the benefit of additional appreciation during 2005, and homeowners had built up more home equity."

During the period of the second quarter of 2005 and the third quarter of 2007, property refinanced had a median appreciation (annual) of 24 to 34 percent. During the last two quarters the appreciation was 8 percent and 12 percent respectively.

Freddie Mac's refinancing estimates come from a sample of properties on which Freddie Mac has funded at least two successive loans. Transactions are further screened to verify that the latest loan is for refinance rather than for home purchase. The Freddie Mac analysis does not track the use of funds made available from these refinances and it is not immediately clear what impact these changes have made or will make on the kind of consumer spending.

Americans have also lost their enthusiasm for adjustable-rate mortgages (ARMs). During the last half of 2007, according to a report released by the Mortgage Bankers Association on Tuesday, fixed-rate first mortgage loans accounted for 63.6 percent of new loans compared to 53.4 percent during the first half of the year.

This change in demand was largely due to a substantial decline in long term interest rates and the narrowed spread between the adjustable rate mortgage (ARM) and fixed mortgage rates. Tightened lending standards for subprime and nontraditional loans, where ARM loans were historically more popular, also reduced ARM originations, and interest only loan originations also declined.

Mortgage Bankers surveys include a greater variety of loans than Freddie Mac reports. The vast majority of Freddie Mac loans are prime conforming loans while MBA includes non-prime and Alt-A loans.

In the second half of 2007, 79.0 percent of all origination dollars were for prime loans compared to 70.0 percent in the first half of 2007, 7.5 percent were non-prime (10.4 percent in the first half of 2007), and 7.8 percent were Alt-A (15.8 percent in the first half of 2007).

Government insured originations (FHA and VA loans) increased as FHA loans replaced subprime and other nontraditional loans. In the second half of 2007, 5.7 percent of origination dollars were government insured loans, compared with 3.8 percent in the first half of 2007.