The parade to refinance

With interest rates hovering near 30-year lows, it comes as no surprise that more and more people are refinancing their mortgages.

The move can lower monthly payments, reduce the length of a current mortgage, or both.

But lately, most people are refinancing for another reason: to put cash in their pockets. Home prices keep surging, and people are getting at the mounting equity in their homes through "cash-out" refinancing – obtaining new loans at least 5 percent larger than the balance of their existing loans. Nearly 7 in 10 of the loans refinanced by mortgage giant Freddie Mac in the second quarter of this year were cash-out deals, a 9 percent increase over the same period in 2001.

Frank Nothaft, chief economist for Freddie Mac, says that by year-end, homeowners will have taken out as much as $100 billion in equity from their homes. This is a slightly slower pace than that set in 2001, when about $140 billion was cashed out.

Rising home values – one of the few financial positives in many Americans' lives of late – makes the strategy hard to resist.

Say you bought a $150,000 home three years ago and took out a $135,000 mortgage. Today that home might be worth $200,000, and the mortgage would have been knocked down to $130,000. You decide to refinance at a lower interest rate, but instead of covering only the amount you owe, you borrow $160,000. As a result, $30,000 winds up in your bank account, perhaps earmarked for college payments or a new kitchen.

What that means, of course, is that US homeowners own increasingly less of their homes. The amount of home equity held by Americans with mortgages is dropping to dangerously low levels, says economist A. Gary Shilling. Twenty years ago, the average equity was 30 percent, says Mr. Shilling. Today it stands at about 16 percent.

That could be a problem if real estate prices deflate, as many experts say will happen if the economy takes another big dip. Shilling is among those predicting a decline over the holiday season, as more consumers hold off on purchases and as employee layoffs continue to build. Homeowners, Shilling and others say, may find themselves owing more than their homes are worth.

Shilling says that lenders, who have made refinancing much simpler and less expensive than ever before, will change their tune as foreclosures continue to mount.

Last month, the number of US foreclosures in process hit 1.23 percent, the highest level in 30 years, according to the Mortgage Bankers Association.

Fannie Mae, the nation's largest home mortgage financer, has already announced a fee increase on cash-out refinance mortgages effective Feb. 1.

The hike can be as high as a half percent. On a $200,000 mortgage, that represents $1,000 a year in interest.

Fannie Mae cites credit risk for its move: Homeowners who tapped equity through cash-out refinancing default more frequently than other borrowers.

Other hurdles to refinancing have cropped up. As homeowners race to get the best interest rates, the time from application to closing has increased.

Just a couple of years ago the process could take as few as 10 days. Today it can take up to 60.

It may take still longer, experts say, as borrowers rush to close loans before the fees increase. A lot can happen in 60 days, and many borrowers are locking in interest rates. That can add cost: The longer the time you lock in, the more you pay.

For homeowners who do press ahead, experts say, the key to drawing real benefits from a cash-out refinancing is knowing how – and how not – to use the cash (see story, below left).

For Jennifer Whitworth, a cash-out refinance helped bring her debt situation under control. Ms. Whitworth, a single mother from Birmingham, Ala., was struggling to meet monthly mortgage, credit-card, and student-loan payments.

In June, she refinanced her mortgage, drawing $80,000 to cover what remained on her mortgage plus another $15,000 in cash.

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