Boosted Cashout Refis?

By: Kenneth R. Harney: RealtyTimes
In the wake of the Fed's 2.5 point boost in short-term rates in 12 months -- plus hints of additional bumps to come - can once-booming home equity credit line continue to be attractive? Is a move to cheaper long-term rates using cashout refinancings already underway? Ken Harney has the answer.

Bye-bye credit lines? Hello cashout refis? In the wake of the Federal Reserve's quarter-point boost in short-term rates last week, floating-rate credit lines -- arguably the fastest-growing product category in the U.S. home mortgage market for the past three years -- are certain to be less popular among homeowners.

With credit lines typically floating at prime-plus-1 percent, many borrowers are about to begin paying 7 ½ percent on their credit line balances. Even more significant for new borrowers, the Fed seems determined to keep ratcheting up short-term rates indefinitely. By the end of the year, or early 2006, credit line balances could be at 9 percent, with the underlying prime rate at 8 percent and the federal funds rate at 5 percent.

Meanwhile 30-year fixed rates remain below 6 percent for conforming mortgages. Directly linked to prices on 10-year Treasury rates in the global capital markets, fixed-rate 30-year loans appear likely to remain near historical lows, according to mortgage economists.

That combination of financial developments could wean Americans off their multi-trillion dollar home equity line borrowing binge, and encourage them to switch to fixed-rate, cashout refinancings instead when they need substantial money out of their properties.

Freddie Mac believes that shift is already well underway. In its just-released survey of refinancings during the second quarter of 2005, it found that 74 percent of all refinancers pulled cash out -- the highest cashout percentage since late 2000. Freddie Mac defines a cashout as any refinancing that produces a new balance that is 5 percent greater than the original balance.

But the reality is that most cashouts are far larger than 5 percent. Say you need $50,000 for a downpayment on a vacation condo, and you have an existing loan balance of $200,000 on a $400,000 home. You can refinance your $200,000 mortgage and take out the needed $50,000 add-on, and probably walk away with a 30-year rate at 5 ¾ percent or 6 percent. Your loan-to-value (LTV) ratio will still look attractively low to mortgage underwriters -- $250,000 gives you a 62.5 percent LTV, a modest increase in lender risk from the 50 percent LTV you had before.

Some Wall Street analysts say the steady ratcheting-up of rates could put a serious crimp in banks' credit line portfolios. Richard X. Bove, a bank stock analyst for Punk Zeigel & Co., forecasts a mass stampede of homeowners to "get rid of their HELOCs (home equity lines of credit) and replace them with larger, fixed-rate mortgages." That stampede could be bad news for big banks that have rapidly built up profitable, bulging books of credit lines.

For example, Bank of America's home equity loan portfolio soared 114.2 percent in the past year, according to Highline Banking Data Services. JP Morgan Chase expanded is portfolio by 153 percent. Credit card issuer MBNA Corp., starting up a push to home equity lines, increased is portfolio of HELOCs by an astounding 4248 percent last year.

Bank executives say they see the handwriting on the wall. Ken Koranda, president of Mid America Bank in suburban Chicago, says the switch from floating-rate equity lines to fixed-rate cashout refis "is happening already, and it's likely to continue if spreads between HELOCs and 30-year and 5-1 hybrid adjustables widen."

Of course, he also hopes his home equity line customers do their cashout refi's with the bank. After all, he said, "they can refi into one of our very attractive fixed-rate alternatives."