Sunday, March 13, 2005

Cash-out refinance boom may be ending

Joe Richter, Bloomberg News

Consumers are finding it tougher to tap the value of their homes to pay for cars, TVs and vacations, which some economists say might restrain economic growth this year.

Cash-out refinancings, in which homeowners take out a portion of their increased home value in one lump sum, might drop 30 percent this year, according to McLean, Va.-based Freddie Mac, the second-biggest buyer of mortgages. Home equity loan growth, which surged as recently as October, might be next to feel the effects of rising interest rates and slower increases in home prices.

"We're already seeing cash-out refinancing fading, but what's new is that home-equity borrowing seems to be leveling off," said Ian Morris, chief U.S. economist at HSBC Securities USA Inc. in New York. "That could weaken consumer spending significantly from about the third quarter."

Thirty-year fixed rates below 6 percent and a 32 percent jump in existing home prices since 2000 have allowed homeowners to tap the equity they'd built up, helping power consumer spending in 2004 by the greatest rate in almost four years.

"Consumption over the last three years, four years has been supported by those high housing prices, and the mortgage refinancing, which those prices help support," said Joseph Stiglitz, a Nobel Prize-winning economist at New York's Columbia University. "If real interest rates rise, then the housing market, which has been very inflated by low interest rates, may come down. That will be a challenge to the economy."

The Washington, D.C.-based Mortgage Bankers Association said March 2 that its gauge of refinancing applications slumped 9.9 percent the previous week, the most since a 12.3 percent decrease in the week ended Nov. 26, and that the share of refinancing as a percent of all mortgage applications dropped to 44.8 percent, the lowest since the week ended Oct. 8.

Home-equity loan growth slowed from a 51 percent rate in late October on a three-month annualized basis to a 15 percent pace in early February, the slowest since the middle of 2001, Morris said. The figures are based on lending data from commercial banks, which provide 55 percent of total home equity loans, he said.

These loans generally are linked to short-term rates, which have been rising as Federal Reserve policy-makers have raised their overnight lending rate. The Fed has boosted the benchmark rate six times since June by 1.5 percentage points to 2.5 percent, and economists are predicting more increases.

"Home-equity growth rates have been through the roof, and that's unsustainable," said Mark Zandi, chief economist at Economy.com, an economic research group in West Chester, Pa. "Slowdowns in housing and mortgage borrowing are probably going to hurt [economic] growth this year."

Not all economists agree that home equity borrowing will evaporate or that a decline in mortgage refinancing and home-equity borrowing will hurt spending.

Home-equity loan demand still is strong, said Bob Walters, chief economist at Livonia, Mich.-based Quicken Loans. Quicken is the nation's largest online mortgage lender, according to National Mortgage News. Many consumers continue to borrow against the value of their homes because it's generally cheaper than credit cards, Walters said.

"When it comes to accessing equity, there isn't a better way," Walters said. "As interest rates rise, that will affect demand, but you have to compare it to other forms of credit."

Home-equity borrowing will also depend on whether home prices keep rising steadily.

There's some evidence that the pace is slowing.

The cost of the average home climbed 1.7 percent in the fourth quarter, less than half of the 4.8 percent increase recorded in the third quarter, according to the Office of Federal Housing Enterprise Oversight, the government agency that regulates government-sponsored mortgage-buyers.

OFHEO said in its report that there were home price declines in 31 of the 265 metropolitan areas surveyed, compared with five out of 245 during the third quarter. The report said that while price declines might not continue in coming quarters, the "clustering" of declines in some regions "is a departure from recent quarters and could signal a change in trends."

Taken as a whole, U.S. home prices rose 11 percent in the fourth quarter compared with a year earlier, the report showed. That's a blistering pace but a slowdown from the 13 percent seen in the third quarter.

The median price of a previously owned home averaged $182,500 last year, up from $138,430 in 2000. Because of the surge, buying a home might be beyond the reach of many potential purchasers.

The affordability of homes fell to a four-year low in 2004 as a surge in prices offset lower mortgage rates, the National Association of Realtors said in a Feb. 3 report.

The group forecasts a 5 percent rise in the price of existing single-family homes this year, down from an 8.3 percent increase recorded in 2004. For 2006, price gains are forecast to slow to 4.4 percent, said Walter Molony, a spokesman for the Washington-based group.

"For a lot of people who have viewed their house as an ATM machine for free money, the psychology is going to change as home prices slow," said Ethan Harris, chief U.S. economist at Lehman Brothers Inc. But unless home prices plunge, job growth might be enough to keep consumer spending from dropping, he added.

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