Cash-Out Refinancing: Sign of the Times?

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Gone are the days when homeowners used their houses and apartments like ATM machines, pulling out equity to pay for vacations and other treats. Nowadays, people are more likely to put money into their homes when they refinance--moving themselves towards a debt-free future. Of the borrowers who refinanced home loans in the first quarter of 2010, 18 percent--nearly 1 in 5--took out new loans that were smaller than their original financing, often writing big checks
Gone are the days when homeowners used their houses and apartments like ATM machines, pulling out equity to pay for vacations and other treats. Nowadays, people are more likely to put money into their homes when they refinance--moving themselves towards a debt-free future.

Of the borrowers who refinanced home loans in the first quarter of 2010, 18 percent--nearly 1 in 5--took out new loans that were smaller than their original financing, often writing big checks to pay off the difference and cut the amount they owe to the banks. All told, three-quarters of borrowers who refinanced kept their loan balance largely unchanged or reduced their loan balance outstanding as a result of the refinance, according to Freddie Mac's latest quarterly Refinance Report.

The share of people who refinanced and took money out, replacing their old home loan with a new loan that was at least 5 percent bigger than their old loan, fell to 28 percent. That the lowest since Freddie Mac started keeping track in 1985.

So has the world changed or have we changed? It would certainly be nice to think that borrowers had gotten smarter and were voluntary choosing to lighten their load of debt. But that's not it....

"The main causes of the decline in cash-out refinance were reduced home prices and tighter underwriting standards for loan-to-value ratios," said Frank Nothaft, chief economist and vice president for Freddie Mac.

Home prices dropped so much in the real estate crash that about a quarter of all borrowers now have home mortgages that are larger than the value of the home, according to First American Core Logic. The value of nearly everyone else's home has also dropped sharply - the Case Shiller Price Index has fallen more 30 percent from its peak in 2006.

At the same time, lenders are much less eager to offer home loans that cover more than the standard 80 percent of the value of a home. Back in the housing boom, mortgage loans were made at an average of 88 percent of the value of homes in 2006, suggesting a 12 percent down payment, according to recent coverage in Reuters.

The combination is forcing many borrowers who refinance their home loans to take out smaller mortgages.

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But thanks to low interest rates, the incentive to refinance is still strong for many borrowers. Half of the borrowers who refinanced in the first quarter cut more than 0.9 percentage points off their interest rate, according to Freddie Mac. That's largely because interest rates, despite months of predictions that they must rise, have stayed close to 5 percent throughout the first quarter, inching upwards only to fall back down.

That happened again last week, when a financial crisis in Greece frightened skittish investors away from short-term investments and into long-term bonds, pushing average interest rates for 30-year home loans back down to 5.0 percent in the week ending May 6. That's down from 5.1 percent, where the rate had stayed for the last three weeks, according to Freddie Mac's Primary Mortgage Market Survey. Rates will probably creep back up to that level as the crisis resolves itself, according to the experts polled by Bankrate.com's extremely helpful Mortgage Rate Trend Index.

But rates won't rise much further--interest rates are expected to stay relatively low all year, averaging 5.3 percent in the second quarter, and rising to an average 5.7 percent in the fourth quarter. Rates won't get to an average 6.0 percent till the second quarter of 2011, according to Northaft.



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