Cash-out refinancing increases

In the fourth quarter of 2005, 80 percent of Freddie Mac-owned loans that were refinanced resulted in new mortgages with loan amounts that were at least 5 percent higher than the original mortgage balances, according to Freddie Mac’s quarterly refinance review. This percentage is up from the third quarter of 2005, when the share of refinanced loans that resulted in homeowners taking cash out was 73 percent. The fourth-quarter percentage of cash-out refinancing is the highest since the third quarter of 2000.

“The refinance share of mortgage applications in the fourth quarter of 2005 was 45 percent, while the average rates on 30-year fixed-rate mortgages climbed 0.4 percentage points and one-year, Treasury-indexed adjustable mortgage rates jumped 0.6 percentage points from third-quarter averages,” said Frank Nothaft, Freddie Mac vice president and chief economist, in a news release. “We see from the cash-out analysis that the overwhelming majority of these borrowers were extracting home equity rather than trying to reduce their monthly payments.”

Nothaft added that one reason borrowers are using the cash-out refinancing option is the recent string of rate hikes by the Federal Reserve Board, which have increased home-equity-loan interest rates.

“Home-equity loans are typically linked to the prime rate … . In contrast, the average rate on 30-year, fixed-rate mortgages is presently near 6.25 percent,” he said. “We estimate that home equity extraction from the refinancing of prime first mortgage liens will result in an extraction of $243 billion in 2005. However, equity extraction in 2006 will likely fall sharply, by a little more than half to about $117 billion, as we expect lower refinance activity and slower house price appreciation.”

Rising rates

Freddie Mac expects the refinance share of mortgage applications to fall to around 37 percent and home prices to grow at an average rate between 6 percent and 8 percent nationally in 2006.

Freddie Mac expects 30-year fixed mortgage rates to average three-tenths of a percentage point higher in 2006 relative to 2005, and the average rate on one-year Treasury-indexed adjustable rate mortgages to rise by seven-tenths of a percentage point.

“Refinancing activity was very strong in the fourth quarter, even with higher interest rates,” said Amy Crews Cutts, Freddie Mac deputy chief economist. “The large share of borrowers who took cash out when refinancing their mortgages combined with the strong overall refinance volume, led to an extraction of home equity through prime first-lien refinances of $70.3 billion, slightly higher than the revised estimate of $67.2 billion extracted in the third quarter.” Freddie Mac expects the share of all refinance borrowers who take out cash to remain high in 2006, due to the relatively high costs of second mortgages and home-equity lines of credit.

Loan activity

In the fourth quarter of 2005, the median ratio of old-to-new interest rates was 1.02. In other words, one-half of those borrowers who paid off their original loan and took out a new one had an interest rate on their old loan that was at least 2 percent higher than the new interest rate.

“Also, in the fourth quarter of 2005, homeowners who refinanced their fixed-rate mortgages lowered their interest rate an average of 0.35 percentage points,” Cutts said. “On an average loan size of $150,000, that lower rate translates into a payment that is about $34 a month lower, for a savings of about $410 annually.”

However, Cutts added that interest-rate savings are not the primary factor in the decision to refinance a home loan.

“Now, the dominant refinance borrower is looking at the best way to consolidate debt or finance a big project, such as a home improvement,” she said.

“And we also have borrowers who took out adjustable-rate mortgages in recent years that are scheduled to have their payment reset this year that may be looking at the option to refinance into a fixed-rate product or into another adjustable-rate mortgage.”[[In-content Ad]]