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By Lynn Adler
NEW YORK, Nov 1 (Reuters) - U.S. homeowners took cash out of their homes in the third quarter at the highest rate in 16 years, spurred by high costs on other types of loans, according to home finance company Freddie Mac FRE.N.
In the quarter, 89 percent of Freddie Mac-owned loans that refinanced got mortgages that were at least 5 percent larger than the original balances. That compared with 88 percent in the prior quarter and was the highest level since the second quarter of 1990, when it was at 91 percent.
The total amount refinanced, however, fell in the third quarter.
“High demand for cash extraction through refinance is being driven by the high cost of home improvement loans and home-equity lines of credit — that is, the cost of alternative financing — and still-strong demand for home improvements,” Amy Crews Cutts, Freddie Mac deputy chief economist, said in a release.
Also, a huge wave of adjustable-rate mortgages (ARMs) created in the past few years are facing their first reset, giving borrowers an incentive to refinance and take added cash, Freddie Mac said.
Refinancing remains high because of the ARM adjustments, though it slipped to 41 percent of total mortgage applications in the third quarter from 42 percent the prior quarter and is well below its record.
Homeowners tapped into their home equity for $82.8 billion in cash in the third quarter, compared with a revised $90.6 billion in the prior quarter. The amount could slide below $65 billion in the fourth quarter, according to Freddie Mac.
Homeowners taking less advantage of home equity wealth could have a significant ripple effect on the economy, if consumers borrower and spend less, analysts have said.
Refinancings hit a record pace in March 2003, accounting for 79 percent of total mortgage applications, Freddie Mac said.
Short-term rates have surged since many of these ARM loans were created, as the Federal Reserve raised official interest rates by a total of 4.25 percentage points over two years starting in June 2004.
Fixed-rate 30-year mortgages now average about 6.4 percent. Freddie Mac predicts the rate will hover between the current level and 6.6 percent through the end of 2007.
Initial rates on one-year Treasury-indexed ARMS are seen between 5.4 percent and 5.5 percent in that period.
In contrast, home equity loans and lines of credit are tied to a prime rate now pegged above 8 percent.
“If borrowers are already refinancing to avoid an interest-rate increase on their adjustable-rate mortgage, they may opt to extract a little cash while they are at it,” Crews Cutts said.
The Mortgage Bankers Association last week estimated that $1.1 trillion to $1.5 trillion of ARMs will be eligible for reset next year.
“Additionally, borrowers who might have considered a prime-rate home-equity loan for a home improvement or other need are turning to cash-out refinance options now that the prime rate is above 8 percent,” Freddie Mac’s chief economist, Frank Nothaft, said in the release.
Half of the borrowers who paid off their original loan and took out a larger new one increased their mortgage rate by about 3/8 percentage point, Freddie Mac said.
The median ratio of new-to-old interest rates was the highest since Freddie began compiling the information in 1985. It may start to trend down, though.
Banks are starting to offer more creative financing for home-equity lines, many with a fixed-rate line of credit option that is at or below the prime rate, Crews Cutts said.
Freddie Mac’s report on homes refinanced also showed a 33 percent median price gain from the time the loans were made, down from 34 percent in the prior quarter.