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Mortgage Borrowers Who Refinance Are Lowering Debt

Chief Economist Frank E. NothaftRecent data show that consumers generally are shedding debt – and lowering or paying down their mortgages is just another way they’re doing it. Between 2007 and the fourth quarter of 2010, mortgage debt declined more than $400 billion, according to the Federal Reserve Board.

With mortgage rates in the four percent range (the likes of which haven’t been seen in more than 50 years), many borrowers have refinanced their mortgages.

Our recent analysis showed that three out of four homeowners who refinanced their first-lien home mortgages in the first quarter of this year, either maintained about the same loan amount or lowered their principal balance by paying-in additional money at the closing table. Fifty-four percent of them maintained about the same loan amount, the highest share since 1985, when Freddie Mac began keeping records on refinancing patterns. In addition, 21 percent of these homeowners reduced their principal balance.

We found that the typical borrower reduced their interest rate about 1.2 percentage points by refinancing during the first quarter. For a 30-year fixed-rate mortgage with a $200,000 loan balance, that’s a monthly payment savings of about $150.

A smaller number of borrowers who refinanced, 25 percent, took “cash-out” and increased their loan balance by at least five percent. The average cash-out share over the past 25 years was 62 percent.

A second Freddie Mac report found that in the first quarter of 2011, fixed-rate loans accounted for more than 95 percent of refinanced loans. This limited use of adjustable-rate mortgages (ARMs) is a shift from a few years ago when ARMs were often used for refinance.

In addition, an increasing share of refinancing borrowers chose to shorten their loan terms at the end of last year. Of borrowers who paid off a 30-year fixed-rate loan, 34 percent opted for a 15- or 20-year loan, the highest such share since the first quarter of 2004. Part of the attraction for such borrowers, of course, is that shorter-term loans have a lower interest rate.

In this tight economy, it’s clear that many homeowners are seeking a little extra peace of mind when it comes to their finances. By choosing a refinance option that reduces their mortgage principal and/or shortens the term of their loan, they will not only worry less, but will pay less for their mortgage over the long term.


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