Home Equity Still Fueling Refinancing

Americans are continuing to treat their homes as cash cows according to a report released this week by Freddie Mac.

During the fourth quarter of 2006, 84 percent of new mortgages that were the result of refinancing were "cash out" loans. Cash out is defined as a new mortgage that has a contract amount at least five percent higher than the balance of the mortgage it replaced.

While the rate of "cash out" refinancings was down slightly from the 87 percent level reported in revised figures for the third quarter it still resulted in $70.7 billion in equity pulled out of American homes in a three month period. In the third quarter, refinancing "liberated" $80.2 billion in cash.

Refinancing itself accounted for 46 percent of all mortgage loans during the fourth quarter, up from 41 percent during the previous period.

Frank Nothaft, Freddie Mac vice president and chief economists said, "The share of mortgages that were for refinance rose in the fourth quarter as 30-year fixed mortgage rates came down to where they started the year. Falling mortgage rates encouraged some people to refinance to lower their payments for example if they had an adjustable-rate mortgage that was scheduled to reset soon, but the primary driver of refinance continues to be equity extraction."

That is demonstrated by another piece of information contained in the report. The median ratio of new-to-old interest rates was 1.06, that is, one half of borrowers who refinanced took out a loan that increased their contract rate by 6 percent or about three-eights of a percentage point.

Another Freddie Mac economist, Amy Crews Cutts, speculated that "many families found it cost effective to cash-out equity through a new first mortgage even though it raised their rate. With the prime rate at 8.25 percent, a home equity loan or line of credit based on that rate may not make sense if the financing need is large, like a major home improvement or college tuition payments and will be paid back over several years."

(Part of the willingness to accept a higher rate also may reflect a pre-emptive strategy; refinance that 5.2 percent three-year ARM with a 6.15 percent fixed rate mortgage before the ARM adjusts to 7 percent.)

Properties refinanced during the fourth quarter of 2006 had enjoyed a median house-price appreciation of 28 percent over the term of the original mortgage, down from 33 percent in the previous quarter. The median age of the old loan was 3.4 years, about one month older than in the third quarter.

Cash-out loans have consistently represented at least 80 percent of refinanced mortgages since the fourth quarter of 2005 and mortgagors have accepted larger interest rates on their replacement loans for the last four quarters. Both of these factors were last present in 2000 and 2001. In the intervening time cash-out loans represented as little as 33 percent of refinancing and the median ratio of new to old mortgages was more likely to be in the 85 to 95 percent range.