Most homeowners traditionally refinance their mortgage to a lower rate. However, recently many homeowners have been willing to refinance to a higher fixed rate for cash-out purposes. In the first quarter of 2006, 88 percent of Freddie Mac-owned loans that were refinanced were for loan amounts that were at least five percent higher than their initial balance, according to Freddie Mac’s quarterly refinance review. The percentage is the highest since the third quarter of 1990.
The percentage of refinanced homes to a loan amount that was at least five percent greater than the original balance has a 95.8 percent correlation with the median appreciation of the refinanced property (see below graph).
Homeowners are increasingly deciding to refinance their property and take cash-out through their mortgage instead of extracting equity from their house through a line of credit. Home equity lines of credit (HELOC) rates, which are typically tied to the prime rate, have risen as the Federal Reserve has increased short-term rates. Based on where rates are today, there could be more than a 200 basis point difference in rate if homeowners choose a 30-year fixed-rate mortgage instead of a HELOC.
However, refinance activity is expected to slow as mortgage rates rise. Freddie Mac estimates that the refinance share of originations will fall from 45 percent from the fourth quarter of 2005 to about 33 percent by the end of 2006. Similarly, the Mortgage Bankers Association predicts in its April 2006 forecast that refinances will fall to 36 percent by the fourth quarter of 2006, but will increase to 39 percent in 2008. The reason for the higher projection is that analysts expect borrowers will refinance their adjustable rate mortgages when the rates begin to reset.
The consequences of the recent Freddie Mac release are that many borrowers who have enjoyed recent house price appreciation rates will rely less on home equity extraction via lines of credit in the short-term and rely more on cash-out refinances. Credit unions should consider what consequences this may have for their product mix and marketing focus.
Learn more about recent credit union mortgage trends in the 2006 Yearbook.