What a surge in refinancing means to the real estate industry
RISMEDIA, Jan. 25, 2007-(MarketWatch)- People looking to extract equity from their homes have increasingly been turning to cash-out refinancing, industry observers say.
A big reason that people are tapping their equity through refinancing comes down to dollars and cents, according to Amy Crews Cutts, deputy chief economist with Freddie Mac. Because home-equity loans and lines of credit are most often tied to the prime rate, now at 8.25%, those options have gotten more expensive even as long-term mortgage rates have remained relatively low, with the 30-year loan averaging about 6.2%.
"It's all about the prime rate," said Michael Kodsi, chief executive officer of Choice Mortgage Bank in Boca Raton, Florida. A good number of his clients would rather take cash out through refinancing — where their mortgage rate will be fixed — as opposed to taking out a loan tied to the prime rate, which has the potential to fluctuate and thereby "could go higher down the road," he said.
Freddie Mac said 89% of the loans it owns that were refinanced in the third quarter of 2006 had loan amounts at least 5% higher than the original mortgage balances, the threshold for considering a loan a cash-out refinancing. It's the highest share of cash-out refinance loans reported since 1990.
Consumers cashed out a total of $82.8 billion during the quarter, down somewhat from $90.6 billion in the second quarter, according to Freddie Mac.
Banks are seeing results of the cash-out trend, too.
"Banks have been reporting that they have not been getting the business of home-equity lines as they had been before," Cutts said.
According to the American Bankers Association, the dollar amount of home-equity loans (including loans made through home-equity lines of credit) has increased by an annualized 14.6% for the first three quarters of 2006, compared with all of 2005. That's down from a 17.4% increase in 2005 and a 31.2% increase in 2004.
The "easy money" in 2004 was an effect of a prime rate at about 4%, said Keith Leggett, senior economist for the American Bankers Association. But as the Fed raised rates, thereby raising the prime rate, that easy money dried up.
"What's happening, you're starting to see the impact of higher interest rates," he said. "As interest rates rose, that … translated into basically a slowing in the rate of growth in home equity lines and home equity loans."
Some homeowners aren't refinancing only to get at their equity. Instead, they're "passive" cash-outs taken by those who are refinancing for a better rate, perhaps in response to an adjustable-rate mortgage reset that has adjusted higher, Cutts said.
In fact, it's those who are facing ARM resets that seem to be the driving force behind an upswing in refinancing that started late last year, said Mike Fratantoni, senior economist at the Mortgage Bankers Association.
While locking in a good rate, some of these homeowners are using the opportunity to pull equity out of their homes while they have a chance — a move that perhaps helps them clean up credit-card debt at the same time, said Keith Gumbinger, vice president of HSH Associates, a financial publisher of mortgage and consumer loan information.
That said, a growing number of homeowners recently have been increasing their mortgage rates through refinancing, Cutts said. "The median borrower increased their mortgage rate by 12%," she said, referring to statistics from the third quarter of 2006. The borrowers considered for that statistic originally had fixed-rate loans, but refinanced either to an ARM or another fixed-rate.
Case by case
So is refinancing to take cash out everyone's best bet? Hardly. It depends on an individual, said Jim Svinth, chief economist for LendingTree.com.
"I always counsel folks to look at all of their alternatives," he said. "If you refinanced two years ago and you have a 4.5% or 4.75% (rate) on the first mortgage, you're not going to want to refinance in today's environment," he said. Of course, if the spread between the mortgage rate you have and the one you can get isn't as big — or if you can refinance to a better rate — it may be a decent option.
Above all, people need to ask themselves, "At the end of the day, what is the cheapest way to borrow this money," said Bob Walters, chief economist with Quicken Loans. "You need to minimize the interest payments that you make."
After all, a home equity line of credit still will offer a better interest rate than most credit cards and interest on these loans is generally tax deductible. Another point to remember: Banks also will sometimes offer a fixed rate for chunks of debt taken out on a home equity line.
There are also costs and fees to consider, so those refinancing should make sure that the move is definitely going to pay off given the expense. Their timeline for repayment is another consideration; if the debt can be paid back in less than a year, a second mortgage or home-equity line of credit may be a better choice, experts said.
Finally, borrowers also should know exactly what they'll use the funds for.
"If you look historically at what people do with the cash-out funds, they fall into one of three buckets," Fratantoni said. One is debt consolidation, another is to make an investment and another is to spend, he said.
Home improvement is often cited as a prudent reason for extracting equity, given that the value of the home — and your future equity — should rise as a result.
Overall, borrowers also need to be honest with themselves before tapping their home equity, especially if the reason for the cash-out isn't a one-time cost, said Jennifer Wheary, a senior fellow at Demos, a nonpartisan public policy research and advocacy organization. She recently completed a report on the issue of home-equity extraction.
"In the short-term, they will feel a sense of relief," she said, referring to those who use the cash to catch up with such things as credit-card payments or medical expenses.
But the relief will be fleeting if they find themselves in the same situation — and this time without the cushion of home equity to fall back on, she said.