Monday, February 13, 2006

Cashing in on your home's value

American homeowners are on the verge of setting a new record in a key mortgage market measure: Cash-out refinancings.
The latest quarterly study by mortgage market giant Freddie Mac found that four out of every five homeowners are pulling out extra money -- often tens of thousands of dollars -- when they refinance their existing loans.
The 80 percent figure is the second highest rate on record, according to Freddie Mac chief economist Frank Nothaft, and is just one point below the record rate of 81 percent set in mid-2000. Equally significant, the rate of cash-outs soared by 24 percentage points in the past 12 months alone -- up from 56 percent in the comparable fourth quarter period of 2004 to fourth quarter 2005.
Moreover, cash-out refis are booming in spite of a half percentage point increase in 30-year mortgage interest rates during the past year. Normally refinancings decline when rates go up, but they accounted for nearly half of all mortgage applications during the fourth quarter of 2005. Most people who did cash-outs last quarter actually increased the note rate on their loans, rather than decreasing them, which is the customary purpose of a refinance.
What's going on here? Are Americans loading on even heavier, potentially dangerous debt loads? To the contrary, says Nothaft. They may in fact be substituting lower cost debt for higher cost debt—a heads-up financial management move.
So why are cash-outs at near record levels now? Nothaft says the key factor has been the 12-month string of short-term interest rate hikes by the Federal Reserve Board. Those increases -- which affect the prime bank rate directly -- have had the side effect of pushing up the cost of home equity credit lines and second mortgages.
Home equity rates are usually linked to the bank prime, and are readjusted by the lender when short-term rates rise. The prime is now at 7.5 percent. Most fully-indexed home equity rates are set at prime-plus-one percent or even higher. That means that equity credit line borrowers are facing rates of 8.5 percent or more once their teaser rate introductory periods expire. Worse yet, those rates could climb higher in the months ahead if the Fed ratchets them up further.
What's the alternative to floating rate credit lines? You guessed it: fixed-rate 30-year primary mortgages which last week averaged 6.25 percent. Evidently, according to Nothaft, large numbers of credit line borrowers are throwing in the towel -- refinancing their primary mortgages, cashing out additional money, and paying off their floating-rate debt.
Rather than irresponsible financial behavior, cash-outs in the present circumstances look like a way to save money and nail down low fixed interest rates. Also, for homeowners who need capital for a major expense -- say a kitchen renovation or a downpayment on a second home -- a cash-out refi at 6.25 percent may well be the most cost-effective way to obtain that money. And thanks to high real estate appreciation rates in many parts of the country during the last several years, homeowners have sizable equity cushions to borrow against.


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