Mortgage refinancing in 2001 and early 2002

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

A significant portion (45 percent) of homeowners who refinanced in 2001 and the first half of 2002 used the opportunity to liquefy some of their home equity. By comparison, about 35 percent of refinancing homeowners in a similar survey in 1999 liquefied equity (not shown in table). The difference in the proportion of cash-out refinancings in the two surveys may have been due to differences in housing market conditions. Home prices had generally appreciated much more rapidly in the years just before the current wave of refinancings than they had in the early and mid-1990s, and thus homeowners had more equity to tap. In addition, consumer credit, particularly credit card debt, rose sharply in the period between the latest two surveys, creating an incentive to repay relatively expensive consumer debt with less costly mortgage debt.

Changes in maturity in 2001 and 2002 refinancings differed somewhat between those who took cash out and those who did not, with the former group more likely to increase the term to maturity of their loans. Of homeowners who did not liquefy equity, 69 percent lengthened the maturity of their loans, and 20 percent shortened it. Among homeowners who liquefied equity, 80 percent lengthened the maturity on their loans while 14 percent shortened it.

As a result of the changes in interest rates, loan maturities, and amounts owed, 52 percent of homeowners refinancing in 2001 and early 2002 had a lower monthly payment after obtaining the new loan, and 26 percent had a higher payment. In part because they took on additional debt, only 27 percent of homeowners who liquefied equity had a lower monthly payment, compared with 73 percent of homeowners who did not liquefy equity.

Uses of Borrowed Funds

Equity liquefied in refinancings is used in various ways, including funding home improvements or current consumption, paying down other debts, and changing the mix of a household's assets. For homeowners in the survey who refinanced in 2001 and the first half of 2002, the most common use of funds, reported by 51 percent of those who took out cash, was to repay other debts (table 6). Paying for home improvements was cited by 43 percent of those who took out cash; and making consumer expenditures, such as vehicle purchases, vacations, education, and medical expenses, was cited by 25 percent. Stock market or other financial investment was cited by 13 percent of the group; real estate or business investment, by 7 percent; and tax payments, by 2 percent. These proportions are similar to those in the 1999 survey, although the earlier survey found that the proportion funding consumer expenditures was somewhat higher.

Looking at the uses of funds in terms of dollars rather than proportion e f loans gives a somewhat different picture. Refinancers taking cash out spent 35 percent of liquefied equity on home improvements and used 26 percent to pay off other debt. They used 16 percent of the funds for consumer expenditures, 10 percent for real estate or business investments, 11 percent for stock market investments, and 2 percent for taxes. That home improvements are generally large expenditures may explain why they account for a greater share of activity when cash-out usage is measured by dollars rather than by number.