Here's another short fuse for the powder keg housing
market -- home owners are tapping the equity till and
increasing their mortgage balances with cash-out
refinances at the greatest rate since late 2000.
A cash-out loan is by nature an equity-depleting loan
and should home owners hit hard economic times at the
same time home appreciation stalls, they may have a
mortgage with no equity cushion to soften the blow.
Home equity is the difference between the value of the
home and the balance on the home mortgage and home
owners may be gambling that difference doesn't reach
zero.
They are also enjoying home value appreciation as high
as it was during the same late 2000 period and the new
loans are being closed with cheaper interest rates.
Cheaper rates can lower monthly payments or keep them
relatively the same.
Freddie Mac's "Cash-Out Refi Report" for the second
quarter of 2005 reveals 74 percent of home owners
trading in their old loan for a cash-out refinance are
doing so to acquire a loan that is at least 5 percent
larger.
The percentage hasn't been that high since the fourth
quarter 2000. Since 1998, the percentage of home
owners refinancing for loans 5 percent larger has been
higher than 74 percent only during each of the four
quarters prior to the fourth quarter 2000. The highest
level since 1998 was 81 percent in the third quarter
of 2003.
During the second quarter this year, only nine percent
of those refinancing to take cash out closed with a
smaller loan. That percentage has been smaller only
four times since 1998. It dropped to 7 percent during
the first quarter of 2001, Freddie Mac reported.
Home owners obviously were cashing in on mortgage
rates that dipped in the second quarter this year and
on the one-year, 23-percent increase in appreciation,
an increase that also hasn't been matched since the
fourth quarter of 2000. Annual appreciation has been
higher only twice since 1998, 24 percent in the second
quarter of 2000 and 26 percent during the third
quarter of that same year.
"The second quarter (2005) cash-out refinance volume
reflects, in part, borrowers responding to the fact
that they may not be able to obtain such favorable
rates in the future to fund home improvements or other
big purchases," said Amy Crews Cutts Freddie Mac's
deputy chief economist.
One half of the cash-out, refinancing home owners, in
the second quarter 2005, had an old interest rate
about 8 percent higher than the new loan, Freddie Mac
said.
However, mortgage market monitors predict mortgage
rates will rise at least to 6 percent this year.
Personal finance experts say home equity isn't
collateral for frivolous expenditures.
The best use of the money is capital improvements and
investments that provide an equal or greater return on
your money than the cost of the loan. Cost-vs-value
favorable home improvements, education for the kids
and successful new business financing are relatively
better uses of equity than, say, buying cars, boats
and trips around the world. Emergency nest eggs, for
unexpected events and debt consolidation can be other
wise and necessary uses. That's provided debt
consolidation doesn't become a habit.
Other more conservative financial planners say, given
the uncertain nature of Social Security and pension
and retirement plans, home equity should remain
untouched until the mortgage is paid off. Without a
mortgage payment, home owners can live relatively
shelter-cost free, with only maintenance and up keep
expenses, at a time when incomes traditionally shrink.
After retirement, should home owners need the equity,
it will be comforting knowing it's available.
The Federal Reserve, concerned that easy-money loans
were prompting home owners to squander their equity,
issued "Credit Risk Management Guidance For Home
Equity Lending," earlier this year also to warn
lenders their portfolios were too heavy with
higher-risk loans. Interest-only, higher loan-to-value
and low- and no-documentation equity loans, the feds
said, are more vulnerable to interest rate increases.
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