Cashout activity remained strong, but the amount of equity extracted declined and is expected to continue weakening amid adjustable-rate loan resets and alternative financing options.
The share of refinance transactions where the new loan amount was at least 5 percent higher than the original balance was 89 percent in the third quarter, according Freddie Mac's latest Cash-Out Refi Report. The share is higher than the revised 88 percent for the second quarter and that of 73 percent in the third quarter 2005.
The latest cashout share is the highest since the second quarter of 1990, Freddie reported.
"Mortgage borrowers continue to refinance their mortgages at a higher frequency than historically would have occurred given the rise in mortgage rates over this year," commented Freddie Chief Economist Frank Nothaft in a written statement. "But the wide proliferation of adjustable-rate mortgages originated in the past few years that are nearing their first interest-rate adjustment provides borrowers an incentive to refinance into a lower-cost ARM or fixed-rate mortgage.
"In addition, borrowers who might have considered a prime-rate home-equity loan for a home improvement or other need are turning to cashout refinance options now that the prime rate is above 8 percent."
The secondary lender expects rates for 30-fixed mortgages to average between the current 6.4 percent and 6.6 percent through the end of 2007 and initial rates on 1-year Treasury-indexed ARMs to hover between 5.4 percent and 5.5 percent.
The median ratio of new-to-old interest rate was reported at 1.12 -- the highest since Freddie began compiling this information 21 years ago -- meaning that one-half of borrowers who refinanced increased their mortgage coupon rate by 12 percent.
"High demand for cash-extraction through refinance is being driven by the high cost of home-improvement loans and home-equity lines of credit, that is, the cost of alternative financing, and still-strong demand for home improvements," said Amy Crews Cutts, Freddie deputy chief economist, in the statement.
However, reported third quarter cashout volume of $82.8 billion decreased from a revised $90.6 billion in the second quarter and is expected to decline to less than $65 billion this quarter, due to lower expected refinance shares overall and lower mortgage origination activity.
"Banks are now starting to offer more creative financing for home-equity lines, with many offering a fixed-rate line of credit option at or below the prime rate," Cutts added. "These fixed-rate second-lien alternatives, which protect borrowers from future interest-rate increases, may reduce interest in cashout refinances of existing first-lien fixed-rate mortgages.
"However, if borrowers are already refinancing to avoid an interest-rate increase on their adjustable-rate mortgage, they may opt to extract a little cash while they are at it."
Freddie said the data was based on a sample of properties on which Freddie has funded at least two successive loans.