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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.
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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