commissioner.org
| Source | Yoshie Furuhashi |
| Date | 06/11/04/06:52 |
| www.nytimes.com
November 4, 2006 Your Money Mortgage Lesson No. 1: Home Is Not a Piggy Bank By DAMON DARLIN Economists are fond of pointing out that "there ain't no such thing as a free lunch." But for several years, as interest rates have fallen, homeowners have gotten something pretty close to it. Anyone who had been diligently paying down a mortgage and others who had just sat back and watched their home appreciate in value were able to refinance and take out the difference between the value of the home and what was still owed, known as equity. Not only did they remove the increased equity in the home as cash, most people were paying lower monthly payments. "People have literally picked up their house at the foundations and shook it upside down like a piggy bank," said Ed Smith, chief executive of the Plaza Financial Group, a mortgage brokerage firm in La Mesa, Calif., near San Diego. Since January 1999, according to figures compiled by Alan Greenspan, the former Federal Reserve chairman, and James Kennedy, a Fed staff economist, in a Federal Reserve Board paper, more than $2.62 trillion has been extracted by homeowners through refinancing and home equity loans. But as rates have gone up, the extraction has continued. In the first six months of this year, even with interest rates rising, more than $511 billion was extracted from homes through cash-out refinancing and home equity loans, and that was more than the amount taken out for all of 2005, a record year for mortgage equity extraction. More homeowners did cash-out refinancings in the third quarter of this year than at any time since 1990, according to Freddie Mac, the mortgage company. Many of them, Freddie Mac said, were scrambling to get out of interest-only mortgages that will soon reset at a higher interest rate. "A lot of folks are squeezing out the last bit of equity from their homes," said Celia Chan, director for housing economics at Moody's economy.com. Economists argue over what effect that money, which they call mortgage equity withdrawal, has had on consumer spending. Homeowners cash out to pay off more expensive credit card debt, remodel the house to build more equity, or just have fun. They may very well have used it to buy another house or not spent it at all, but added it to savings. Economists really are not certain. "I guess it is one of those mysteries," said Christopher D. Carroll, an economics professor at Johns Hopkins University. "I don't think anyone knows what the answer is." Nevertheless, mortgage equity withdrawal is closely watched as an indicator of the general economy because, Mr. Carroll said, "there is a lot concern that a cooling housing market could result in a sharp fallback in consumer spending." A recent paper that Mr. Carroll helped write contends that for every $1,000 change in housing wealth there is an immediate propensity to consume about $20 more. The wealth effect, as the phenomenon is called, is twice as high for housing wealth as it is for stock wealth, Mr. Carroll and his associates said. Economists will argue for many years to come how much a decline in home prices damped consumer spending. But this much is already clear — it is a lot more expensive to tap home equity. It is one reason economists predict consumer spending will slow in 2007 and even more in 2008. The slowdown is already being seen in home remodeling. The Joint Center for Housing Studies at Harvard found that over the last 12 months homeowners have spent only 1.6 percent more on remodeling projects than they did in the preceding 12 months. That rate was running at close to 20 percent throughout 2005 and the first four months of 2006. Homeowners with equity built up in their home can still get at it, but it is no longer free money. Unlike the situation five years ago, when a person seeking to refinance heard the same thing from nearly every mortgage broker and lender — do it! — now the advice is varied. The best thing to do in most cases is to leave the equity alone. No one expects home prices to appreciate sharply. A cautious consensus among economists is developing that prices will decline in some areas, but that the depreciation will not be sharp or prolonged. But should home values fall, a homeowner who has depleted the built-up equity risks finding himself paying a mortgage on a home that is worth less than the mortgage. There is another change in the market that could block a homeowner's desire to borrow against the increased value of the home. "Lenders are being very cautious today as they do appraisals," said Patty McGill, president of Money Marketing, a mortgage broker in Frederick, Md. "They are scrutinizing appraisals so they are not lending on phantom equity." She said she had done very little equity extraction business recently. These mortgages carry higher interest rates than first mortgages because lenders view them as riskier. It is usually about two percentage points above the prime rate. Right now you can get one for about 9 percent to 10.25 percent compared with borrowing at about 6 percent on a fixed 30-year loan. Sometimes, and a homeowner has to analyze this carefully because it is not always the case, a homeowner might be better off refinancing the first mortgage than taking out the home equity loan, even if that means refinancing at a higher interest rate. If you have a mortgage at 5 percent, why would you give it up for an even larger one at 6 percent? Opinion is divided on this issue. Mr. Smith, for example, is an advocate of the "blended rate," the marketing term lenders use for paying an interest rate that is higher than the one on the first mortgage, but lower than a second mortgage's. But the fact remains that it will cost homeowners more. "If you reach out to tap equity, but can't afford to make the payments, what use is it?" Mr. Smith asked. "Most people's income has not grown to allow them to tap it. If you pull money out," you have to pay for it eventually. Some mortgage brokers say that some homeowners become obsessed with the low interest rate they are paying on their first mortgage and do not realize that a new first mortgage might be cheaper than adding the home equity loan. "We call that low rate the 'cocktail rate,' because it is the one people brag about at cocktail parties," said Neil Sweren, president of the mortgage brokerage company Allymac Mortgage Services in Owings Mills, Md. He is recommending a 30-year loan, with the payments in the first 10 years being interest-only. Take a homeowner who borrowed $425,000 a number of years ago to buy a home that is estimated to be worth about $620,000. The homeowner has convinced himself that he should use about $75,000 of that increased value to fix up the house, where he intends to stay for 10 years. The homeowner could pay about $562 a month to borrow the money in a home equity loan. In Mr. Sweren's plan, he would trade in the original $425,000 30-year loan with a fixed rate of 5.5 percent on which he had been paying $2,413 a month. He would borrow $500,000 at 6.5 percent. Under the new first mortgage, the monthly payments during the first 10 years would be $2,708, or $295 more than the old one, a 12 percent increase. Of course, without the interest-only feature, that payment would be another $452 a month. In the 11th year, the payment jumps to $3,727 a month for the next 20 years. In that period the entire loan must be paid off. The homeowner pays $567 a month more than he would have paid with a conventional 30-year loan. If it sounds like a losing proposition, you are not alone in that opinion. Still, Mr. Sweren said the larger the overall debt, the more sense it makes to arrange a refinance rather than a home equity loan. Most people are not going to go for deals like that and will leave the piggy bank undisturbed. Ms. Chen, the economist, predicts that there will be a lot fewer equity withdrawals in 2007. "I don't think there is a compelling reason to extract equity at this point," she said. "People will just wait." |
Copyright (c) 1998, Joongpil Cho