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15-year high for cash-out, larger-balance refinancing

By Broderick Perkins

Refinancing homeowners are tapping the home equity till at a rate not seen in more than 15 years, and most of them are paying a larger interest rate for the new home loan.

That's a troubling trend.

Interest rates have risen a full percentage point since last year, and home values are threatening to decline. A larger, higher-cost loan could leave equity-tapping homeowners with a home worth less than the balance on outstanding mortgages now saddled with larger payments.

Also, a cash-out loan is by nature an equity-depleting loan. Should homeowners hit hard economic times in a market of stalled or reversed home value appreciation, the double whammy could leave them without an equity cushion to soften the blow.

Equity is the difference between the value of the home and the balance on the home mortgage.

In the first quarter this year, larger equity-tapping loans were created in 88 percent of Freddie Mac-owned loan refinancings resulting in mortgages with balances at least 5 percent greater than the original mortgage, Freddie Mac reported.

That's the highest level since the third quarter of 1990--the peak of another housing boom, when the rate of appreciation on homes with refinanced mortgages was 52 percent. Freddie Mac said during the first quarter this year, the median rate of appreciation on homes with refinanced mortgages was 30 percent.

Most of the refinanced loans also cost more.

"Almost no one is refinancing to reduce their interest rate in today's environment. In fact, the first quarter of 2006 is the first time in 20 quarters in which the new mortgage rate was higher than the old one for more than half of refinancing borrowers," said Frank Nothaft, Freddie Mac vice president and chief economist.

Just under one-half of 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 2 percent lower than the new interest rate, Freddie Mac reported.

"The first quarter of 2006 was the first time in five years that we saw more than half of borrowers increase their mortgage rates when they refinanced. The difference is small enough that the average borrower's mortgage payment barely changed, but it is a significant turn from the trend of significantly lower payments that we came to enjoy since the start of 2001," said Amy Crew Cutts, Freddie Mac's deputy chief economist.

The share of Freddie Mac-owned loans that were refinanced fell in the first quarter to 44 percent, down from 45 percent in the last quarter of 2005. The drop was often because interest rates on all mortgages increased during the same period by 0.02 percent to 0.25 percent, Freddie Mac reported.

That share will fall further to 36 percent this year as home equity extraction drops from $244 billion in 2005 to only $170 billion this year, due to higher interest rates and slower rates of appreciation.

The current average of about 6.6 percent rate on a 30-year fixed-rate mortgage remains well below the 35-year average rate of 9.4 percent, Freddie Mac reported.

Cutts said, "Many borrowers will be looking to refinance this year when their adjustable rate mortgages hit the first rate reset or as a low-cost way to fund a major project, such as a home improvement, or to consolidate other debt."

A more expensive first mortgage with a fixed rate could be a smart move if it halts the upward march of interest rates on adjustable rate mortgages (ARMs).

But any equity tapping now is riskier than it was a few years ago.

San Jose's home prices are overvalued by more than 44 percent, according to "House Prices in America," jointly produced in mid-June by Waltham, Mass., based Global Insight, an economic, financial and industry analyst and Cleveland, Ohio, based National City Bank.

Walnut Creek-based PMI Group, a private mortgage insurer, said in its latest "Economic and Real Estate Trends Report," the San Jose-Sunnyvale-Santa Clara housing market has a 54.8 percent chance of experiencing home price declines in the next two years.

Published June 21, the University of California-Los Angeles Anderson Forecast's "The California Report: At the Tipping Point," says statewide California's home prices will continue to rise by 7.5 percent his year and then flatten, rising only 0.3 percent in 2007, followed by a 4.1 percent decline in 2008.

Also, the California Association of Realtors recently revised projections for home prices to rise by only 8 percent this year, down from the original 10 percent increase forecast. Sales will decline 17 percent, far off the original forecast, a 2 percent decline, CAR says.

Real estate writer Broderick Perkins, executive editor of San Jose-based DeadlineNews.Com, writes regularly for this newspaper.