Cash-out Refinance Activity Strong In Third Quarter 2005

November 3, 2005

Rising Costs of Home Equity Lending Helped Spur Demand for Cash-out Refinancing Option

McLean, VA – In the third quarter of 2005, 72 percent of Freddie Mac-owned loans that were refinanced resulted in new mortgages with loan amounts that were at least five percent higher than the original mortgage balances, according to Freddie Mac's quarterly refinance review. This share is unchanged from the second quarter of 2005.

"Interest rates on 30-year fixed-rate mortgages remained low, averaging 5.76 percent, in the third quarter while the prime rate, key to home equity lending and lines of credit, rose to 6.75 percent," said Frank Nothaft, Freddie Mac vice president and chief economist. "The sharp rise in the cost of home equity lines of credit and the expectation that mortgage interest rates will go higher over the next year induced homeowners to look towards the refinancing option to extract home equity for home improvements or other investment purposes now."

"We are forecasting that home equity extraction from the refinancing of prime first mortgage liens will result in an extraction of $204 billion in 2005, up from the $142 billion converted to cash in 2004," noted Nothaft. Freddie Mac expects home sales to hit a new record again in 2005 as low fixed mortgage rates combined with teaser discounts on adjustable-rate mortgages maintain affordability, even as home prices rise.

"Home equity is also extracted through home sales when homesellers roll only part of the equity from the sale into new downpayments. A recent study co-authored by Fed Chairman Alan Greenspan put this form of equity extraction at roughly $350 billion in 2004 and $300 billion in the first quarter of 2005 at an annualized rate."

Freddie Mac expects 30-year fixed mortgage rates to rise through the end of the year, ending with a fourth quarter average near 6.0 percent, approximately one-quarter of a percentage point higher than the third quarter average.

"Refinancing activity was strong in the third quarter, even with higher interest rates with 44 percent of new mortgage applications being submitted for refis," 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 $60.4 billion, almost equal to the revised estimate of $60.7 billion extracted in the second quarter. With the expectation that mortgage rates will rise further in the fourth quarter, refinance volumes overall should slow but cash-out refis will continue to be in demand, and equity extraction through refinance should hit over $200 billion this year, falling to about $114 billion in 2006."

In the third quarter of 2005, the median ratio of old-to-new interest rate was 1.09. 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 nine percent higher than the new interest rate.

"Also, in the third quarter of 2005, homeowners who refinanced their fixed-rate mortgages lowered their interest rate an average of 0.57 percentage points. On an average loan size of $150,000, that lower rate translates into a payment that is about $55 a month lower for a savings of more than $660 annually," said Cutts. "This same time last year, borrowers who refinanced lowered their interest rate by an average of 0.72 percentage points. As mortgage rates increase, the borrowers who have an incentive to refinance will largely be those seeking to exchange home equity for cash or those who are hitting the adjustment period on their adjustable-rate mortgages."

The Cash-Out Refinance Report also revealed that properties refinanced during the third quarter of 2005 experienced a median house-price appreciation of 23 percent during the time since the original loan was made, unchanged from the second quarter 2005. For loans refinanced in the third quarter of 2005, the median age of the original loan was 2.6 years, one month older than the median age of loans refinanced during the second quarter.

These estimates come from a sample of properties on which Freddie Mac has funded at least two successive loans. Transactions are further screened to verify that the latest loan is for refinance rather than for home purchase. The Freddie Mac analysis does not track the use of funds made available from these refinances.

Source: Freddie Mac

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