U.S. Homeowners Shift to 15-Year Loan Refinancing to Add EquityPrashant Gopal
While millions of U.S. homeowners have negotiated lower monthly mortgage bills in an effort to avoid foreclosure, Cecelia Kirchman happily added $250 to her payment when she refinanced last August.
Kirchman took out the new loan to reduce her interest rate to 4.5 percent from 7 percent, and slice the term in half to 15 years. She said she has paid down more principal in the past 10 months than in the previous six years of owning her home in the suburbs of Washington, D.C.
“It’s unbelievable,” said Kirchman, a marketing director for a financial-planning firm who lives in a ranch-style house in Frederick, Maryland, with her husband, Mark. “For very little more each month, I’m paying it off much more quickly.”
The couple are among the growing number of “equity builders” -- creditworthy homeowners with steady jobs and enough cash to lock in near record-low interest rates and shorten the length of their loans, said Stuart Feldstein, president of SMR Research Corp., a market-research firm in Hackettstown, N.J., that focuses on financial services. Others are opting for what’s known as a cash-in refinancing, in which borrowers write a check at the closing to shrink the amount they owe on the property.
The rationale for equity building when foreclosure isn’t a threat is simple. The future interest payments homeowners can forgo by reducing the length of their loan or pumping cash into the deal is greater than what they’d otherwise earn in safe investments such as a bank account or money-market fund, SMR’s Feldstein said. As an added incentive, the 15-year fixed mortgage is the cheapest relative to the 30-year loan than it’s ever been.
The portion of borrowers refinancing in January who took 15-year mortgages rose to 29 percent from 11 percent two years earlier, according to the most recent data available from CoreLogic Inc., a real estate information firm in Santa Ana, California. Mortgages with 30-year terms accounted for 52 percent of refinancings in January, down from 80 percent in January 2009.
The share of cash-in refinancings reached a record 44 percent in the fourth quarter, according to data from Freddie Mac dating to 1985. While the share fell to 21 percent in the first quarter as mortgage rates climbed, it was almost double the quarterly average over the past 26 years.
“They are people who -- rather than waiting for home values to rise -- are taking matters into their own hands,” Feldstein said. “They are building equity on their own.”
Refinancing applications have increased 36 percent since the start of the year, according to a Mortgage Bankers Association index. The average weekly rate is about a third below last year’s pace as millions of Americans can’t qualify for a new loan.
Falling home prices reduced average homeowner equity to 38 percent of property value in the first quarter, close to the lowest level since World War II, according to a June 9 report by the Federal Reserve. More than 28 percent of homeowners with mortgages were underwater in the first quarter, meaning they owe more than their properties are worth, Zillow Inc., a Seattle-based real estate data company, said on May 9.
“Refinancing is apt to be subdued,” Don Brownstein, whose Stamford, Connecticut-based mortgage hedge fund was at the top of Bloomberg Markets’ list of 100 best-performing funds in 2010, said yesterday in an interview with Erik Schatzker on Bloomberg Television.
The Treasury Department’s main foreclosure-prevention plan produced about 600,000 permanent loan modifications, short of its goal of up to 4 million. Lenders have completed 3.85 million private modifications, according to the department.
Borrowers have complained that modifications are being delayed by banks losing paperwork, and that foreclosures move forward even as homeowners believe talks to lower payments continue. Some modifications result in higher monthly bills because borrowers must catch up on missed payments and fees.
Mortgages remain hard to get and borrowers’ credit ratings have been damaged by mounting foreclosures and job losses. Fannie Mae and Freddie Mac in October will be required to lower the maximum limit on conforming loans that they insure to $625,500 from $729,750, which will make it more expensive for some borrowers in the priciest markets to secure government-backed mortgages. The government-sponsored entities temporarily raised the ceiling from $417,000 in 2008 for high-cost areas such as New York City as the jumbo mortgage market collapsed.
Some borrowers who don’t meet minimum equity requirements to refinance are making up the difference with money from their savings accounts, said Keith Gumbinger, vice president of HSH Associates, a loan-data firm in Pompton Plains, New Jersey. Others are completing cash-in refinance deals to avoid mortgage insurance.
One New York photographer whose business was especially strong used more than $250,000 in cash this month to bring his balance to the conforming limit. That enabled him to qualify for a slightly lower rate, said Michael Moskowitz, president of Equity Now, a New York-based mortgage lender.
“For some borrowers, this is the only way to have access to today’s rock bottom interest rates,” Gumbinger said.
Cash-in deals are the flip side of cash-out refinancings, in which borrowers pull equity of their homes, money they can use for home renovations, tuitions or vacations. The volume of cash-out deals tumbled during the real estate bust as borrowers were left with little or no equity.
The median price of a home has declined by almost one-third nationally since peaking in 2006. Cash-out deals accounted for 25 percent of refinancing in the first quarter, compared with 88 percent four years earlier.
Falling rates are making shorter-term loans more appealing to middle-age borrowers who can afford higher payments, Gumbinger said.
The spread between 15-year and 30-year fixed rates widened last month to a record of 0.82 percentage point, according to Freddie Mac data going back to 1971. Last week, it was 0.81 percentage point, with the 15-year rate at 3.68 percent and the 30-year rate at 4.49 percent.
The spread has grown because of increased investor demand for 15-year loans, which tend to be given to older, less-risky borrowers, Gumbinger said.
Switching to a 15-year term made sense for Kirchman, 55, who has no plans of moving anytime soon and is looking ahead to retirement.
Kirchman, whose monthly payment increased to $1,350 from about $1,100, would have taken a 10-year loan if she had qualified for it, she said. She owes $112,000 on the four-bedroom house.
“I’ll be retiring in 10 to 12 years,” Kirchman said. “I don’t like the thought of still having that as an expense. I’d rather be taking trips.”
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