As conforming mortgage rates drop closer to 7%, market observers are expecting the first major refinancing period since November 1998. On the home-equity front, however, the wave is not expected to be as strong.
"Normally, home equities will not respond to a refi wave nearly as much as the agency market," said Tom Zimmerman, an asset-backed researcher at UBS Warburg (formerly of PaineWebber). "There are a couple things that have changed over the past couple years since the 98 wave that will make them even less sensitive to interest rates."
He added that if rates rally modestly further, the current refi wave has potential to reach that of 1998.
Among those changes are prepayment penalties that have been attached to subprime mortgages since the last refi period in 1998.
"Prepayment penalties will persuade many homeowners not to refinance their home-equity loan," Zimmerman said.
"On the other hand, you are starting to see the expiration of some two- and three-year penalties for loans that were originated in 1998 and 1997," added Ivan Gjaja, vice president of ABS research at Salomon Smith Barney. "And once the penalty expires, you could get a pretty large spike, basically pent-up refinancing demand. The borrowers are waiting for the penalties to expire."
Coupled with prepayment penalties is that home-equity interest rates are not decreasing at the same rate as conventional mortgage rates, which could also persuade borrowers not to refinance. Gjaja is predicting a pick-up of 3% to 4% constant prepayment rate (CPR) for the home-equity sector over the course of the year.
"They're pricing it higher than they used to," Zimmerman said. "There's more of a lag between changes in the rates that many of the home-equity issuers charge and what the prime issuers charge."
Another factor in determining how home equity prepayments will pan out is that consolidation in the industry has made lenders less aggressive in stealing accounts from other home equity issuers, Zimmerman said.
Furthermore, a slowdown in home price appreciation could also dictate how much prepayment speeds will increase. "Price appreciation is actually a significant factor in subprime speeds," Gjaja said, adding that as of the third quarter of 2000, year-over-year price appreciation was 7%. "I don't think we're going to come anywhere close to that this year. So slowdown of price appreciation will actually keep the speeds bounded."
"Prepayment speeds will pick up," Zimmerman said. "There will be some refinancing in the home-equity market; it just won't be as much as it happened in 98."