While refinancing as a share of overall mortgage activity continues to decrease as rates rise, Americans who do refinance continue to liberate home equity to pay for home improvements, bill consolidation, consumer purchases and other discretionary spending.

Freddie Mac reported on February 8 that 80 percent of its owned loans that were refinanced during the fourth quarter of last year were for loan amounts that were a minimum of five percent higher than the loans that were replaced. At the lower level the increase might be accounted for by the need or desire to wrap points and fees into the final loan amount. This would be particularly true of higher risk loans where poor credit or marginal equity would require higher fees. In the third quarter 73 percent of refinanced loans resulted in cash out and the recent fourth quarter, figures are the highest since the third quarter of 2000 and, in fact, are near the highest this century. Since the beginning of 2000 cash out loans of this nature have ranged from a low of 33 percent in the second quarter of 2003 to a high of 81 percent the very next quarter.



Refinancing in the fourth quarter of last year represented 45 percent of total loan applications. According to Frank Nothaft, Freddie Mac's chief economist, "The overwhelming majority of (these) borrowers were extracting home equity rather than trying to reduce their monthly payments. One reason that (homeowners) are using the cash-out refinance option is that the string of rate hikes by the Federal Reserve Board has pushed the rates on home-equity loans up." Home equity loans are usually tied to the prime rate which is currently at 7.5 percent. According to Freddie Mac, the average rate last week of fixed rate first mortgages was 6.23 percent.

Nothaft estimated that "home equity extraction from the refinancing of prime first mortgage liens" will result in borrowers taking out $243 billion when numbers are in for last year. Nothaft said that equity extraction will probably fall and fall sharply in 2006 to around $117 billion, reflecting both lower refinancing activity and a decrease in the acceleration in house prices which have made cash-out refinancing such an unprecedented source of available money for the last few years. The report forecasts that the overall rate of refinancing activity will fall to around 37 percent of all mortgage activity through the year.

According to Amy Crews Cutts, Deputy Chief Economist, the extraction of equity through prime lien refinancing in the fourth quarter amounted to $70.3 billion in volume compared to 67.2 billion in the previous quarter. She also said that Freddie Mac expects cash-out refinances to remain high through this year because of the relatively high costs involved in secondary lien borrowing.

Borrowers who traded in old mortgages for new got an old-to-new ratio of 1.02 which means that one half of those borrowers received a new interest rate at least two percent less than the old one. Ms. Cutts said that "In the fourth quarter of 2005, homeowners who refinanced their fixed-rate mortgages lowered their interest rates an average of 0.35 percentage points. On an average loan size of $150,000 that translates into a savings of about $34 a month. That, however, is not the primary factor driving refinancing. "Now the ... borrower is looking at the best way to consolidate debt or finance a big project such as a home improvement. And we also have borrowers who took out adjustable rate mortgages in recent years that are scheduled to have their payment reset this year and are looking at the option to refinance into a fixed rate product or into another adjustable rate mortgage.

Freddie Mac's estimates come from a sample of properties on it 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."

Numerous economists have speculated that much of the continued consumer spending that has been propping up the economy over the last year or two has been funded by cash-out refinancing. With Frank Nothaft's projection of a steep dive in cash-outs it will be interesting to see how such a loss of stimuli will impact the overall economy in months to come.