With the housing market in good health, unaffected by the slowdown in the economy, cash-out refinancing activity is expected to remain strong.
According to Freddie Mac, 50% of the refinancings that occurred in the first quarter of this year were five percent higher than the original mortgages. This represents the amount of cash-out refis recorded by the Agency that happened during the quarter.
In a related report, The Wall Street Journal recently published an article saying that it is a common practice for homeowners to cash out $20,000-$40,000 in home equity.
A Salomon Smith Barney report mentioned that private mortgage insurer MGIC found that on the average borrowers at the end of 2000 upped their first mortgage LTV by 6% and increased their note rate by 60 basis points and their outstanding balance by $41,000.
The upward trend in home prices, rising about 9% from last year, has fueled cash-out activity.
"Lenders are hoping that housing prices are going to continue to appreciate at their historic trend rate," said Michael Hoeh, senior portfolio manager at Dreyfus Corp. "If home prices start to fall, then you have a potential for tremendous losses in mortgage credit portfolios."
Other factors
The question of whether cash-out refinancings are going to continue also depends on existing mortgage rates.
The main motivation for doing a cash-out refi for those in a 6 or 6.5 pool, for instance, is to tap the equity in their homes. But if mortgage rates are in the 9% area, for instance, then the motivation would be lost.
"You are not going to pay two extra points just to get $20,000 in equity," said a mortgage analyst.
There is also the question of seasonal housing turnover, which usually peaks in the summer months, June and July.
Cash-out refis that are not strongly dependent on mortgage rates depend more strongly on whether there is healthy housing turnover activity. However, sources say that it is difficult to gauge how much cash-out refinancings rely on housing turnover.
According to the analyst, theoretically, cash-out activity could start to diminish sometime in October, the month when housing turnover typically starts to decline, provided that rates remain constant.
The combined factors of unchanging rates and seasonal considerations will most likely cause the cash-out refi phenomenon to slide away, said the analyst.
Cash-out hits
discount coupons?
Analysts say that in the recent refi wave, some discount coupons were prepaying at a 16%-18% constant prepayment rate (CPR), which is atypical behavior. Usually discount coupons prepay only at 6%-12% CPR.
The acceleration in discount speeds, sources say, could possibly be attributed to cash-out refinancings.
Though most experts say that cash-out refinancing impacts all coupons across the board, some say that they are asymmetrically affecting discounts because borrowers in these coupons tend to have larger loan balances.
With cash-out refis going strong, what now?
According to the Salomon report, "The high levels of cash-out activity could change things going forward."
Salomon said that because of strong home price appreciation and cash-outs, loan sizes are getting bigger. The report compared average loan sizes of new fixed-rate mortgages to those loans from a year ago and found that conventional loans sizes grew by 14% and government loan sizes increased by 7%.
These loans, said Salomon, are increasing the amount of household debt and if a major slowdown occurs, "borrowers with bigger loans would be more vulnerable because their leveraged positions could hamper their ability to trade up or do a cash-out refinance."
Credit quality is also going to be a major issue going forward.
Analysts say that even in an environment were there are not many cash-out refinancings, the possibility of rising LTV is there. Obviously, there would be more of a danger of this when people are constantly taking cash out of their homes.
"People are not deleveraging like they used to and this might be having an impact on credit quality in terms of LTV," said a mortgage analyst.
However, just because a loan is a cash-out refinancing, it does not necessarily mean that it is riskier.
"You can counterbalance the increased riskiness of the loan with credit enhancement," said Mark Adelson, a director at Nomura Securities.
