Low rates driving more ‘cash-in’ refinances

February 2, 2011

A record number of homeowners are kicking in cash when they refinance their mortgages, in most cases to qualify for interest rates that are now near historic lows, mortgage financier Freddie Mac reported this week.

In the fourth quarter, 46 percent of borrowers who refinanced their primary mortgages brought cash to settlement to lower the balance on their loans, Freddie Mac said. That’s the highest share of so-called “cash-in” refinances since the company started tracking the numbers in 1985.

Borrowers, in essence, are buying peace of mind about their debts by moving to more affordable mortgages and, according to the firm, coming out ahead by using cash that’s earning little interest in the bank to realize significant savings on their monthly loan payments.

“It turns out to be an easy calculation for many people,” said Frank Nothaft, Freddie Mac’s chief economist.

The trend marks a sharp reversal from the days of the housing boom, before the mortgage meltdown. Back then, people pulled cash out of their homes to pay for vacations and other expenses. The deals peaked in 2006, when an estimated 86 percent of prime borrowers with non-government backed loans cashed out a record $318 billion.

The “cash-out” deals fizzled out when home values plunged. Last year, borrowers cashed out only $32 billion, the lowest volume since 1997 when adjusted for inflation, Freddie Mac said. By contrast, cash in refinances have climbed every year since 1997.

Low interest rates are one of the main drivers behind the jump. The average rate on a 30-year fixed-rate mortgage hit a low of 4.17 percent in mid-November. It has hovered in the high 4 percent range since then, averaging 4.8 percent last week. With rates expected to rise further this year, it’s no wonder borrowers are eager to refinance.

“Over the course of the past 18 months, we’ve done about 4,000 cash-in refinances and I’d say that borrowers were bringing cash to the deal in more than half of these,” said Erika Tucker, a real estate attorney at Monarch Title, a Washington area firm.

Some borrowers did so out of necessity. With values tumbling, many homeowners owed more on their mortgages than their homes were worth. They could not refinance without coughing up cash.

“The cash-in deals are a by-product of the negative equity many borrowers have in their current homes,” said Greg McBride, a senior financial analyst at Bankrate.com.

Then there are people such as Mark Lenhart, 43. He and his partner wrote a check for $20,000 to refinance their D.C. condominium in December.

The couple had an adjustable-rate mortgage that was due to reset this month and then every year thereafter. Concerned about the prospect of rising rates, they wanted to refinance into a 30-year fixed-rate loan. But they did not have the 5 percent equity needed to qualify, which is why they paid down their loan balance.

“If interest rates went up quickly over the next couple of years, we would have been in trouble,” Lenhart said. “It was a source of panic for me. We are very lucky that the mortgage rates are as low as they are right now so we could do this.”

Other borrowers are kicking in cash so they can avoid paying private mortgage insurance. Lenders require private mortgage insurance if the amount borrowed covers more than 80 percent of the value of the home.

But an even larger share of borrowers are bringing cash to the table to meet certain loan limits within the three-tiered mortgage system now in place in areas with pricey homes, including the Washington region, said Eric Gates at Apex Home Loans in Rockville.

The lowest rates apply to 30-year fixed-rate mortgages that do not exceed $417,000 and meet guidelines set by Fannie Mae and Freddie Mac. Investors perceive these loans as safe because they have the government’s guarantee.

The highest rates apply to loans larger than $729,750. Investors stopped buying those “jumbo” loans when the mortgage market soured and their rates shot up.

In the same expensive markets, an in-between rate can be found for loans from $417,000 to $729,750. That middle tier was created when the federal government tried to help pull down jumbo rates by allowing Fannie Mae and Freddie Mac to buy larger loans, hence making them more attractive to investors.

“The difference in interest rates can be pretty significant,” Gates said. “There are plenty of people who are paying down their balances to meet the various loan limits.”

Among them is Amy Rifkind, an attorney who wrote a check for about $70,000 when she refinanced her home in the District. By doing that, Rifkind and her husband brought down their loan balance below the $417,000 mark and secured a 4.25 percent rate.

“We had gains in the stock market that we wanted to pull out and we had cash in savings as well that was sitting there making practically no interest,” she said. “We figured we might as well pay the loan down and get an even lower rate.”

dina@washpost.com

Dina ElBoghdady covers housing policy for The Washington Post.
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