Mortgage refinancing in 2001 and early 2002

Federal Reserve Bulletin, Dec, 2002 by Glenn Canner, Karen Dynan, Wayne Passmore

Under these extreme assumptions, the recent wave of mortgage refinancing added $22.7 billion to PCE between January 2001 and March 2002. On an annual basis, the increment would be $18.1 billion. This amount represents 1/4 percent of average annual PCE ($7,024 billion) over the period. (18) Positing that half the liquefied equity that reportedly funded home improvements was spent instead on items included in PCE would raise the estimated maximum increment to PCE to 1/2 percent.

Our estimate of an upper bound for the percentage contribution of refinancing activity to residential investment is larger than that for PCE, mainly because residential investment spending is small relative to PCE. The estimated $46.3 billion of liquefied equity that refinancers reported using to fund home improvements over the fifteen-month reference period corresponds to an annual figure of $37 billion. Comparing this amount with the $448 billion average annual level of residential investment over the period, an upper bound for the contribution of refinancing activity to the level of residential investment is 8.3 percent.

The survey results also provide evidence about the influence of refinancing activity on some key aggregate financial statistics. For example, the $132 billion of home equity liquefied in 2001 and early 2002, net of the $5.8 billion estimated to have been used to pay down second mortgages, can account for 20 percent of the $616 billion growth in the home mortgage stock between the beginning of 2001 and March 2002. Further, the actual increase in consumer (nonmortgage) credit between the beginning of 2001 and March 2002 was $131 billion, corresponding to an annual rate of increase of 6.6 percent. If households had not used an estimated $28.1 billion of liquefied equity to pay down nonmortgage debt over the period, consumer credit would have expanded at an average annual rate of 8 percent.

SUMMARY

Over the past ten years, millions of homeowners have taken advantage of lower mortgage interest rates and higher home values and have refinanced their mortgage loans. For many, the decision to refinance was motivated by a desire to reduce their monthly mortgage payments, either by obtaining a lower interest rate or by extending the maturity of their mortgage. According to the University of Michigan's Surveys of Consumers, most homeowners who refinanced their mortgages in 2001 and early 2002 did lower their mortgage rates, and a significant proportion also borrowed additional funds by taking out a new mortgage that was larger than the outstanding balance on their former mortgage plus closing costs. A large proportion of homeowners who cashed out equity from their homes used these funds for home improvement or the repayment of other debts. This boom in cash-out refinancing activity has likely boosted consumption spending materially over the period covered by the survey, though the magnitude of the effect of such transactions on consumption spending is difficult to estimate.