Hard
to believe it's already that time again, but Freddie Mac's Economic and Housing
Research Group are out with their forecast for 2018. The headline is that they expect the economic
environment to remain favorable for housing and mortgage markets, with moderate
economic growth of about two percent, solid job gains, and low mortgage
interest rates. In other words, Deja vu
all over again.
There
will be, they say, three trends driving the 2018 mortgage market: an increase in purchase mortgage volume;
cooling of rate refinance activity, and more borrowers tapping their home
equity. They put forward specific expectations for each.
Increases
in the volume of purchase mortgages will be the result of modest gains in both
home sales and home price growth. Thus
far in 2017, home sales are the highest in a decade, but are unlikely to grow by
much going forward. Inventory problems
will continue to limit sales in the short term and longer-term trends like the
aging of the population and declining mobility across all age groups will hold
down existing home sales. New home sales
will become a more important force once single-family construction picks
up. Freddie Mac forecasts home sales,
both new and existing, will increase by about 2 percent next year.

Home
price growth has been strong. FHFA
reports growth in its House Price Index (which includes Freddie Mac's purchase
mortgage price data) at 6.6 percent from the second quarter of 2016 to the same
period in 2017 and, in some markets, prices are up 10 percent on an annual
basis. Freddie Mac sees gradual gains
for residential construction and moderate increases in mortgage interest rates
reducing price growth next year to an average of 4.9 percent.

The
mortgage market has been shifting slowly, and often in fits and starts, from
one dominated by refinancing to a more purchase oriented one. Freddie Mac's economists expect that will
continue next year. The refinance share
of the market will decline to around 25 percent, the lowest since 1990.
Refinancing
has been sustained at a high level for some years by rate refinancing. With rates
moving up - although that has also been by fits and starts, the potential for this
type of refinancing has declined. Freddie Mac says one concern is that a sudden
rate spike could virtually eliminate it. They cite as an example, a 2-percentage
point jump in the 30-year rate that occurred from the third to the fourth
quarter in 1994. The dollar volume of
refinancing fell by 80 percent in response. A similar spike now would be likely
to prompt the same outcome.
Even
if rates remain relatively flat, refinance volumes are likely to decline. Exhibit 5 shows Freddie's assessment of rate
refinance potential in July 2017 versus that of a year earlier. Even with
little change in interest rates, 30-year conventional rate refinance potential
next year will be the lowest it has been in years.

The
economists note however, that refinancing has not fallen as much as their
estimate of rate refinance potential.
While Exhibit 5 shows a potential decrease of 63 percent in refinancing
originations, in reality they have only fallen by 48 percent. The exhibit covers only part of the market
and other sources of refinance are filling in some of the gap left by rate
refinancing.
Shortening
of the rate term has become a popular reason for refinancing, representing 35
percent of those originations during the second quarter of this year. Term
refinancing has had at least a 30 percent share every quarter since early 2013
as low rates give borrowers the ability to pay down principal faster.
Refinancing
from FHA loans into conventional financing is another source of
originations. CoreLogic estimates as
many as 250,000 FHA borrowers could chose this route to rid themselves of
ongoing FHA annual insurance premiums.
As
rate refinances ebb, cash-out refinancing has increased. Rising home prices have helped existing
homeowners grow their equity and those looking to remodel, consolidate debt, or
pay off student loans, are looking to that equity to do so. Some chose to cash out by refinancing into a
larger mortgage, while others are tapping equity through a second lien, usually
a Home Equity Line of Credit (HELOC).
Freddie
Mac's Quarterly Refinance Statistics track conventional prime cash-out
refinancing. In the second quarter of
2017, homeowners cashed out $15 billion in equity compared to $13.8 percent the
previous quarter and $19.1 billion in the fourth quarter of 2016.
Those
amounts are paltry when compared to the cash-out refinancing book in 2006 and
2007. In those two years homeowners
pulled out between $80 and $90 billion in equity each quarter. Further, while
cash-out represented about 30 percent of the aggregate amount of refinancing in
those two pre-crisis years, it represented only half that in the most recent
period this year.

Freddie
Mac says homeowner equity was up to $13.7 trillion in the first quarter of this
year. As home prices keep rising,
cash-out activity is also likely to rise. Even if mortgage rates rise or remain
flat, cash-out will become a larger and larger share of total refinance
activity. Typical cash-out refinancings
result in a loan amount three to five times as large as the equity cashed
out. If that extracted equity averages
$20 it would mean refinancing volume of about $300 billion each year. But, the
Economists say, "Even if the share of cash-out refinance activity increases
dramatically, the level of overall cash-out activity will likely remain well
below the levels we saw last decade and mortgage debt growth will remain modest
by historical standards."