Over the past two years, falling interest rates have generated a powerful surge in home buying and in mortgage refinancing that has helped the country weather a recession and a somewhat sluggish recovery without jobless rates rising above 6 percent.
Yesterday, Freddie Mac reported that interest rates on 30-year fixed-rate home mortgages dropped to 5.93 percent this week, the lowest level since at least 1965 and one in a string of new lows set this year.
Federal Reserve Chairman Alan Greenspan and others have said low rates have allowed homeowners to extract some of their equity by refinancing, and spend that money to boost the economy even at a time of huge stock market losses and corporate job cuts. "Cash borrowed in the process of mortgage refinancing [has been] an important support for consumer outlays this past year," Greenspan said in a speech in New York City last week.
A new study by three Federal Reserve economists, published last week in the December issue of the Federal Reserve Bulletin, found that in 2001 and the first half of this year about 63 percent of all U.S. homeowners had a mortgage and nearly half of them refinanced those mortgages. Millions more have done so in recent months, according to the Mortgage Bankers Association of America's refinancing activity index.
The economists, Glenn B. Canner, Karen Dynan and S. Wayne Passmore, concluded that many homeowners reduced their monthly mortgage payments even though they may also have increased the size of their mortgages. Collectively households turned almost $132 billion worth of the equity in their homes into cash, with an average of $26,723 worth of equity withdrawn.
A separate recent analysis by economist Mark Zandi of Economy.com, done for the Homeownership Alliance, estimated that about $170 billion worth of equity would be extracted during 2002.
The support that refinancing has given the economy could wane somewhat next year, Greenspan cautioned last week, because so many households have already refinanced that the rates they're now paying may not be much higher than rates available on new mortgages.
"However, applications for refinancing, while off their peaks, remain high," the Fed chairman said.
"Moreover, simply processing the backlog of earlier applications will take some time, and this factor alone suggests continued significant refinancing originations and cash-outs into the early months of 2003."
The surveys of homeowners used by the Fed economists to provide data for the study in the Federal Reserve Bulletin showed that more than one-third of the money was used to pay for home improvements. Just over one-fourth went to repay other debts, such as credit card balances and car loans. Only 16 percent was spent on consumer items, such as vacations, new appliances and so forth.
Of the remaining 21 percent, 2 percent was used to pay taxes and the rest split about evenly between stock market or other financial investments and real estate or other business investments.
As a result of refinancings in the period covered by the Fed study, the average interest rate on the new mortgages was 6.82 percent, 1.83 percentage points lower than the 8.65 percent average rate on the previous mortgages. However, in cases in which homeowners took out equity, 9 percent of them ended up with a higher rate than before.
As part of the process, some homeowners who had an adjustable-rate mortgage switched to a fixed-rate loan, while some who had fixed-rate loans switched to adjustables. The latter moves probably were because rates on ARMs were lower than those on fixed-rate mortgages. For instance, this week the initial rate on one-year ARMs was only 4.07 percent, according to Freddie Mac, the lowest rate since the company began tracking ARMs in 1984.
Nearly one-fifth of the refinancers took advantage of the lower rates to shorten the maturity of their loans -- for example, moving to a 15-year mortgage from a partially paid-off 30-year one. But fully three-fourths lengthened their mortgages' maturities by taking new 30-year loans.
Slightly more than half of refinancers ended up with a lower monthly payment. Just over one-fourth had a higher monthly payments -- either because they took a shorter-term mortgage or because they increased the amount they owed by extracting equity. The remainder had no change in their payments. On average, the term of the new mortgages increased by 29 months over the old ones.
"Allowing for both the longer maturity and the decline in the mortgage interest rate, the implied average reduction in the mortgage payment was $135 monthly, or $1,621 annually," the Federal Reserve Bulletin article said. However, taking out all that equity raised the average mortgage amount to $132,443, which offset a large part of the otherwise lower monthly payment. As a result, the average payment was lowered just $35 a month, or about $418 annually. In total, that reduced mortgage payments by $4.7 billion a year.
But many homeowners include mortgage interest payments as an itemized deduction on their personal income tax returns, and taking that into account reduced the annual saving to just $3.2 billion, the Fed economists concluded.
Freddie Mac's report yesterday said 15-year fixed mortgages fell to 5.32 percent this week, tying a low set last month. That rate, the 30-year rate and the one-year ARM rate all assume an average origination charge of 0.6 points, or six-tenths of 1 percent of the loan.