With interest rates on home equity loans rising, more people are turning to cash-out refinancing to pay for home improvements, business investments or to consolidate debts, Freddie Mac economists report.
Some 88 percent of Freddie Mac-owned loans refinanced in the second quarter of 2006 resulted in new mortgages with loan amounts at least 5 percent higher than the original mortgage balances. That’s the highest cash-out rate Freddie Mac has seen since the second quarter of 1990.
“The incentive to take cash out of home equity is partially driven by the rapid rise in short-term interest rates like the prime rate,” said Amy Crews Cutts, deputy chief economist for Freddie Mac. “Many borrowers have seen their rates on home equity lines of credit — which are tied to the prime rate — rise. Now they are consolidating those (home equity) loans into a new first lien mortgage to reduce their mortgage payments.”
Freddie Mac estimates $500 billion in first-lien mortgages will adjust this year and another $650 billion in second liens will see at least one rate change. This quarter Freddie Mac recorded $81 billion is cash-outs, up from $74.1 billion in the first quarter. The share of all mortgages applications that were for refinance slipped to 42 percent, compared with 44percent in the first quarter.
Freddie Mac expects cash-out activity to remain strong throughout the rest of the year if interest rates continue to climb gently. Its economists expect 30-year fixed mortgage rates this year to average a little more than half a percentage point higher than last, and for the average rate on one-year Treasury-indexed adjustable-rate mortgages to rise by slightly more than one percentage point.
For five years before 2006, Freddie Mac reports, the median refinance borrower was reducing their first-lien mortgage rate. Now, half of borrowers who refinance are moving into loans with interest rates averaging nearly 7 percent more than their old rate (in other words, a loan with a 6 percent interest rate would be refinanced at 6.4 percent).
One reason borrowers can afford to pay higher interest rates is that their homes have appreciated in value. Freddie Mac’s Cash-Out Refinance Report found that the median appreciation of homes refinanced during the second quarter of 2006 was 33 percent from the time of the original loan — 3.2 years, on average.