As home
values have soared in recent years and interest rates have fallen to their
lowest levels in decades, record numbers of homeowners have refinanced their
mortgages. While homeowners refinance to reduce their monthly payments or
shorten the term of their mortgages, many also cash out part of their equity.
Such borrowers are using this cash to pay off credit card debt, finance college
educations, modernize their properties, buy second homes or even take exotic
trips.
In just the last
two years, more than 15 million mortgages were refinanced, according to the
Mortgage Bankers Association. The refinancing amounted to nearly half of the
$2.5 trillion of all mortgage debt outstanding.
The amount of
equity taken out by homeowners nationwide who refinanced amounted to about $84
billion in 2001 and $90 billion in 2002, according to Frank Nothaft, chief
economist for
Home equity for all
families across the United States grew by about $500 billion last year, Mr.
Nothaft said. This heady rise in home values coincided with exceptionally
attractive interest rates. In recent weeks, fixed-rate 30-year mortgages, for
instance, have fallen to 40-year lows of less than 6 percent and certain
adjustable mortgages have fallen below 4 percent. A Freddie Mac analysis for
2002 indicated that the average refinanced mortgage had an interest rate about
one and one-eighth percentage points lower than the original mortgage.
This fortunate
pairing of growth in home value and reduction in mortgage rates effectively
pumped more that $274 billion into the economy in 2001 and 2002, accounting for
20 percent of the real growth in the nation's gross domestic product during
that time, according to a recent study of mortgage refinancing commissioned by
the Homeownership Alliance. The alliance is a national coalition that includes
realtors, home builders, community bankers and Freddie Mac and
For individual
homeowners, the combination of reduced interest rates and the increased value
of their homes has resulted in welcome opportunities. Take the example of a
young couple in Long Island, who, because the husband is an undercover
policeman, spoke only on condition of not being named. Almost five years ago,
they bought a home for just under $200,000, and today it is worth about
$350,000.
Now they plan to
repay the $146,000 remaining on their initial 30-year fixed-rate mortgage loan
with its 7 percent interest rate by taking out a new 30-year mortgage for
$196,000. The interest rate on the new mortgage is fixed at 5.875 percent. That
will leave them with payments of $1,137 a month, about $100 more than before.
But the refinancing will enable the couple to add central air-conditioning,
upgrade the bathroom and modernize the kitchen.
A more rarefied
level of financial sophistication is reflected in the refinancing moves of
Steven Schnall, chief executive of the New York Mortgage Company. In 1994 he
bought a three-bedroom condominium on the Upper East Side. Five years later
when he and his wife, Sherri, were engaged, she sold her apartment and they
used the proceeds to buy the smaller condo next door to his and then spent
$100,000 to combine the two.
In 2002, with the
combined units appraised for more than twice the purchase price, Mr. Schnall
took out an interest-only adjustable-rate second mortgage starting at 4 percent
on which the monthly payment covers only the interest and none of the
principal. At the end of the loan term, one year and renewable, the entire
principal balance will be payable in full.
The couple then used
the proceeds of that loan to invest in several publicly traded Real Estate
Investment Trusts, which paid distributions of 8 percent to 12 percent
annually. Thanks to the spread between the interest rates that they paid on
their mortgage and the REIT payments that they received, the Schnalls were able
last year to cover both the second mortgage and the entire mortgage payment on
a new second home in Bridgehampton.
For Dolores and
Oscar Ruiz, a working couple with a 2-year-old son, the focus was on paying off
debt when they decided two years ago to refinance the $205,000 mortgage on
their three-bedroom Cape in New Jersey to gain a 6.85 percent rate on their new
30-year loan, compared with 7.75 percent on the former loan.
Homeowners who
refinance are routinely advised to consider taking a 15-year mortgage to
replace a 30-year mortgage, in order to pay off the loan in a much shorter time
and save significantly on the amount of interest paid.
The Ruizes briefly
considered taking a 15-year loan, but finally decided that the 30-year loan
would be the better choice, considering their income and debts, and they took
out a new mortgage for about $265,000, based on the increase in the value of
their house. Despite the lower interest rate on their new 30-year loan, the
Ruizes now pay $400 a month more than the $1,815.50 a month they paid on their
previous mortgage. But the extra $400 is much more manageable than the $3,500 a
month they had been paying on their credit cards.
"We've managed
to pay off the entire debt; we rarely use our credit cards; and we've put money
away for expanding the house for when we have more children," Mrs. Ruiz
said during a recent conversation. After adding that she and her husband are
weighing several options for expanding the house, Mrs. Ruiz acknowledged that
there is a good chance the couple will refinance again. She added,
"Refinancing was the best thing we did."
MR. NOTHAFT, the
Freddie Mac economist, said the decision to take a 30-year or 15-year
fixed-rate mortgage usually depends on the borrowers' level of comfort,
something economists cannot measure.
"A lot of
people take comfort in paying off their mortgage in 15 years because they want
the certainty of knowing that they'll own their house free and clear in
retirement," he said, adding that borrowers who can handle the
significantly higher payments on a 15-year loan, compared with 30 years, will
end up saving a considerable amount of money.
But whatever the
length or amount of the loan, Mr. Nothaft stressed that borrowers need to make
thoughtful, prudent choices. One of the most prudent, he advised, is not to
take all the equity out of one's house. One reason, he said, is that the equity
in the average family's house represents one-half of the family's net worth.
Many financial
advisers can provide examples of cases where prudence was not in evidence.
According to Jay Gelbein, a financial planner in Staten Island, a few years
ago, a Staten Islander who earned a modest salary working for New York City
began buying a particular dot-com stock, which eventually was worth
approximately $5 million. His goal in life was to own a gold-tinted Jaguar, but
he did not want to cash in any part of his soaring stock. Instead, he
refinanced his family house, which was valued at about $600,000, to buy his
dream car, which cost $160,000. Very soon after he bought the car, the Jaguar
owner's stock drove off a cliff.
By the time the
client came to Mr. Gelbein for advice, he was left with only his heavily
mortgaged house and his car. But because his salary was not sufficient to
afford the new mortgage payments, which had almost doubled to $4,000 a month,
and because the bank was threatening foreclosure, the client had no alternative
but to sell the Jaguar at a substantial loss, Mr. Gelbein said and to refinance
his house. To do so, he had to pay off the existing loan by stretching out the
repayments over a longer term.
A large majority of homeowners who refinance, of course,
use their equity for purposes they consider more essential. For example, last
summer Nassau County clients of Raymond D. Mignone, a financial planner in
Little Neck, Queens, refinanced to take out $40,000 for their daughter's
wedding. Other clients who refinanced last summer used $20,000 in equity to fly
to Nepal for 10 days to celebrate their 30th anniversary.
Richard J. Russell,
the president of the Richland Equity Resources Corporation, a Manhattan
mortgage broker, told of a client who had lots of money but little judgment in
handling it. In 1993 the client obtained a $1 million mortgage from Chase bank
and bought a house in Manhattan in the East 90's. When it was appraised about
13 months ago, its value had soared to $5 million. Hearing that, the client
decided to refinance the house and take out $2.5 million $1 million to pay debts
and the remainder for reasons he was reluctant to discuss.
But the biggest
hurdle in the client's loan quest was that his financial history included a
number of tax liens, which resulted in his having low credit scores. Those
scores known by the acronym FICO for Fair, Isaac & Company, a financial
services company in California that developed the mathematical model for
determining the scores are taken into account in the majority of mortgage
decisions.
ALTHOUGH the
client's wife had $4 million in cash invested in securities, and had the
documents to prove it, Mr. Russell said, several banks denied them the loan
because of the applicant's low FICO scores. But when the same financial
documents and credit scores were shown to Washington Mutual, it lent the
applicant the $2.5 million whereupon he and his wife promptly flew to the
south of France and bought a villa for $1.5 million. When Mr. Russell asked
why, since their principal residence is still in Manhattan and since they
rarely travel far from home, the husband said, "We just liked it; besides,
it was a good buy."
A client of Robert
B. Walsh, a financial planner in Jersey City, had a small advertising agency in
Westchester County that was profitable until the Sept. 11 attacks; after that,
business fell off. But rather than close shop, he refinanced his mortgage and
took out $65,000 to keep the ad agency going. Soon thereafter it occurred to
him that real estate held possibilities for those willing to work hard, so he
enrolled in a program to obtain his real estate license. Although the ad agency
is now down to a one-man part-time shop, it is still in business, Mr. Walsh
said, and the one-man real estate venture has been doing quite well.
James Van Metter, a
financial planner who lives in Yonkers and has an office in nearby Bronxville,
N.Y., refinanced the mortgage on his own home last year and took out an extra
$25,000 in cash. Soon thereafter he and his family took a Christmas vacation in
La Pe๑ita de Jaltemba, a small Mexican village near Puerto Vallarta. And when a
real estate agent showed them some beach properties overlooking the Pacific
Ocean, they bought three lots for a total of $14,000.
"We plan to
build a house on one lot," Mr. Van Metter said, "and maybe rent it
out and even retire there some day. In the worst case, we'll hold it for five
years or so and then sell it."
Some equity taken
out of refinanced mortgages is used in helping others. Mr. Russell of Richland
Equity Resources told of a client in his 80's who recently financed his home in
Nassau County and took out $200,000 in cash to buy a $160,000 co-op in Great
Neck for his daughter, a single woman in her 50's who has anorexia and
currently lives with her father. Unable to work, her only income is from
Supplemental Security Income, which covers disabilities.
There are many such
examples, according to Lewis J. Altfest, a financial planner in Manhattan. He
cited a father on Long Island who refinanced his house to give his somewhat
free-spending son and daughter-in-law a $500,000 down payment on a house priced
at more than $2 million, and a father in Washington who refinanced his home to
give his daughter and son-in-law a $50,000 down payment on a house in Queens.
While such
generosity is not uncommon among families, several financial planners and
mortgage brokers said that since the terrorist attacks, they had noticed a
palpable change in what homeowners do with the money they take out when they
refinance.
"Generally
speaking, since 9/11 more people are living for today," said Frank Sisco,
a financial planner with the Financial Management Corporation in Harrison, N.Y.
"With or without refinancing, they're buying vacation homes, saying,
`Let's live and enjoy ourselves now.' "
Gary Schatsky, a
financial planner in Manhattan, said that after Sept. 11, "there was an
increase in a sense of mortality," which resulted in such things as people
spending for expensive vacations.
But others are more
restrained. In fact, he added, one of his biggest challenges is trying to talk
millionaire clients in their 70's into enjoying themselves, but rarely
succeeding because they are restrained by "Depression-era
mentalities."
Somewhat similarly,
Peter Giammarinaro, a financial planner in Basking Ridge, N.J., said,
"With so many people unemployed, they want to reduce their debt
load."
Not everyone
succeeds. "A lot of people say that they want to refinance so they can pay
off their credit cards and other debt first thing," said G. Joseph Fava, a
mortgage consultant with BDS Financial Services in White Plains. "But when
you meet up with them a little later and ask how their debt-repayment plans
were working out, they're likely to hesitate a minute, then say something like,
`I went to Atlantic City and lost a little.' "
Debt repayment is
not necessarily the only prudent use of equity, planners say. Mr. Nothaft said
that economists would consider tuition or other educational costs "a human
capital investment."
Mortgage brokers
and financial analysts say a growing number of refinancers are interested in
buying rental properties. "I see a lot of people these days who are
borrowing against their current property for the down payment on a new
house," said Frank M. Craparo, president of Homestead Mortgage Services in
New Rochelle, "and then not selling but renting."
Mr. Van Metter in
Bronxville said one of his clients was refinancing his house, taking $100,000
out and holding it in abeyance until a rental property becomes available in
nearby Eastchester. Another client, a lawyer in Hastings-on-Hudson, built a
summer house near Rhinebeck about a year ago, and now he is thinking of using
the equity in his Hastings house to buy or build another house near Rhinebeck,
this one a rental property.
The growth in house
values that helped to fuel the refinancing boom has been a double-edged sword
for homeowners wanting to move to a large house. The solution is sometimes to
expand in place, using the proceeds of a refinancing. "Here the housing
stock is so expensive that it's almost impossible to move up in house
size," said Nan Bailey, a financial planner in Larchmont, "so
homeowners build up and out."