The refinancing of mortgage loans is often an important component of total origination volume. For example, a survey of a dozen or so large mortgage banking companies revealed that refinancing volume in recent months accounted for 15 to 20 percent of total application volume. At the peak of refinancing activity in late 1986 and early 1987, nearly half of all origination volume involved refinancings.
An interesting aspect of refinancing is that, in most cases, it involves converting some home equity into cash. In this regard, refinancing is like home equity lines of credit, second mortgages and other methods to convert equity.
Given the obvious importance of refinancing, generally, and as a means to convert home equity into cash, in particular, it is not surprising that a recent article prepared by the Federal Reserve Board (Fed) on the subject makes interesting reading. The article, entitled "Mortgage Refinancing," appears in the August 1990 issue of the Federal Reserve Bulletin. The article begins with general comments about why homeowners refinance, then turns to reporting results from a nationwide survey of homeowners who were asked a series of questions about their mortgages.
In reviewing the reasons homeowners refinance, several motives emerge. First, and most important, homeowners refinance to reduce interest costs on their existing loans. As simple and obvious as this motive is, deciding exactly when to refinance and which mortgage instrument to use is complicated. Discounted, after-tax interest savings resulting from refinancing must be enough to offset after-tax closing costs. Because interest savings accrue with time, the length of time the homeowner plans to remain in the home is a key factor. Further, if interest rates are declining, as they typically are when refinancing activity picks up, homeowners must decide whether savings gained by waiting for rates to drop further offset savings lost by paying interest at a higher rate while waiting. Finally, homeowners must weigh the advantages and disadvantages of ARMs versus FRMs.
A second major motive to refinance is to cash out equity to use for other purposes, such as financing home improvements, buying consumer goods, paying off other debts and the like.
A third motive is to reduce monthly payments even if interest rates are not lower. This can be accomplished, for example, by refinancing a fully amortizing 30-year FRM with 20 years remaining by a new 30-year FRM at the same interest rate.
The Fed survey tells us a great deal about homeowners and their mortgages. Table 1 summarizes some of the basic findings. To begin with, 46 percent of homeowners nationwide own their homes free and clear. However, there are significant regional differences. In the Midwest and South, 49 percent of homeowners had no mortgage debt; but in the Northeast, it was 44 percent, and in the West, only 34 percent. These latter regions had brisk turnover of existing homes during much of the 1980s, which probably contributed to the relatively large proportion with mortgage debt.
Of homeowners who have mortgage debt, 20 percent had refinanced at the time of the Fed's survey and 15 percent had home equity loans, with some overlap in these two groups. Of those who refinanced, nearly 60 percent cashed out some equity above the amount needed to cover closing costs.
Table 2 shows the major uses of cashed-out equity arranged by the means used to convert the equity. As the table shows, regardless of the means of converting equity, the two single most important uses are for home improvements and the repayment of other debts. For home equity lines of credit, use for education expenses, medical expenses and auto purchases was also common. Changes in tax law in recent years almost certainly spurred the use of home equity lines of credit for these purposes. In the case of refinancings, use of cashed-out equity for these purposes was much less common. A large item in the "other" category under refinancings was real estate investments.
As of 1989, 18.4 percent of the loans that were refinanced had been ARMs. Of these, 29 percent were refinanced into other ARMs, while 71 percent switched to FRMs. Of the 81.6 percent of loans that were originally FRMs, 79 percent were refinanced into other FRMs, while 21 percent switched to ARMs. The net result was that the ARM share of refinanced loans rose modestly.
Finally, the Fed survey reveals that there were significant regional differences in the extent to which homeowners cashed out equity. Of those who refinanced, 69 percent cashed out some equity in the West and 71 percent in the Northeast, but only 49 percent in the Midwest and 32 percent in the South. These regional differences almost certainly reflected the explosive price appreciation and equity build-up in the former two regions during part of the 1980s. [Tabular Data 1 and 2 Omitted]
Thomas M. Holloway Senior Economist
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|Title Annotation:||refinancing of mortgage loans|
|Author:||Holloway, Thomas M.|
|Date:||Oct 1, 1990|
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