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86 Fed. Res. Bull. 441 (2000)
The Effects of Recent Mortgage Refinancing

handle is hein.journals/fedred86 and id is 959 raw text is: The Effects of Recent Mortgage Refinancing Peter J. Brad ; Glenn B. Canwer, and Dean M. Maki, of the Board's Division of Research and Statistics, prepared this article. Marcin Stawvarz provided research assistance. In recent years, rising home prices, generally falling interest rates, and a desire to convert accumulated home equity into spendable funds have combined to provide millions of homeowners with the opportunity and motivation to refinance the mortgage on their primary residence. In many cases, refinancing results in a lower interest rate and lower monthly mortgage payments, allowing homeowners to spend or save that portion of their incomes no longer dedicated to servicing mortgages. When they refinance, some homeowners liquefy the equity they have accumu- lated in their homes by borrowing more than they need to pay off their former mortgage and cover the transaction costs of the refinancing. They use the funds raised in such 'cash-out refinancings to make home improvements, to repay other debts, or to pur- chase goods and services or other assets. The Federal Reserve Board closely follows refi- nancing activity as well as home equity lending, another form of borrowing used to liquefy accumu- lated equity in homes. Both topics have been the focus of Board-sponsored surveys of households and of previous articles in the Federal Reserve Bulletin) To learn more about the extent to which homeown- ers have been using refinancings to liquefy the equity in their homes and the way they have used the funds raised, the Federal Reserve sponsored questions con- cerning mortgage refinancing on the March through May 1999 Surveys of Consumers, monthly surveys conducted by the Survey Research Center of the University of Michigan (for details see appendix A. I. See Glenn B. Canner James T. Fergus. and Charles A Luckett, Home F-quity Lines of Credit. hederal Resiv'e Bult.in vol. 74 (June 9S), pp. 361-73: Glenn B_ Canner, Charles AJ Lockett, and Thomras A Durkin, Htome Etquity Lending, ederal Resere Butle- tin. vol 75 (May 1989), pp. 333-44 Glenn B. Canne. Charles A. tLuckett, and Thomas A. Durkin, Moortgae Refinancing, Federal Resern.e Bulletin, vol. 76 (August 19901), pp. 604--12: Glenn B. Canner. Charles A. Lucken. and Thomas A. i)arkin, Horne Equity Lending: Eidence from Recent Sur ,. T'ederI Reser Bulletin, vol. 80 (July 1994) pp. 571- 83: and Glenn B Canne, Thomas A. Duin, and Charles A. Luckett. 'Recent Developments in Home Equity Lending, Federal Reseo B letlin, vol 84 (April 1998), pp. 241 -5 Such surveys are an im-portant source of information on both the characteristics of a homeowner's mort- gage and the homeowners use of borrowed funds. This article presents estimates, based on the survey findings, of changes in monthly payments resulting from refinancings, the amount of funds homeowners raised in the process, and how homeowners used the funds. Also presented are rough estimates of the aggregate effects of refinancing on the U.S. economy, including the effects on consumption spending. THE DECISION TO REHFATNCE Choosing whether and when to refinance a home mortgage is an important and often difficult decision that involves a careful balancing of costs and bene- fits. Some of the factors to be considered are known with certainty and are readily quantifiable; others. such as the future course of interest rates, cannot be known with certainty. Balancing Costs and Benefits In general, the question of whether to refinance arises whenever current interest rates on mortgages fall below the rate on the homeowner's existing loan. At such times, the homeowner must weigh the prospec- tive after-tax savings fror lower monthly payments on a new, lower-rate loan against the after-tax costs of the refinancing transaction itself, including any mortgage fees (points) and application and appraisal tees. Because the savings fhom lower interest pay- ments accumulate slowly over time as the loan is repaid. the amounts that would be saved in a refiant- ing must be discounted to their present value and compared with the costs of the transaction, often referred to as the closiug costsS.2 If the discounted 2. The comparison is noat always sraightforward, as [ie home- owner in iany instances has a choice of either paying the transaction costs as a lup sum at the time of thc refinancing or adding the costs to the amoun beiing refiranced lhe cost-f1enefit comparison is rela- tively easy in the Iormer case but more complicated in the lateT Tn facilitae tie cou'parison, the alier-tax present value of the financed transattin i costs inust be decermined if the mnterest rile oil the new loan is used as the discount rate in the alcutation, the pre-tax present value of the financed iransacoon costs equals the Ilump stM payenCot

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