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The decline and the return of refinancing

 
Think Tank
Anand Bhattacharya,
 Ph.D.
Professor of Finance Practice at Arizona State University
Over 25 years of experience, notably president and CEO of Countrywide Capital Markets, authored/co-authored over 65 publications

Last time, we asked Dr. Michael Seiler from The College of William & Mary to explain what impact fewer refinances will have on the market as a whole. This time around, we asked Dr. Anand K. Bhattacharya, professor of Finance Practice at the W.P. Carey School of Business at Arizona State University to explain why refinances declined in the first place and exactly what type of market conditions will bring them back.

Below is the ninth installment of our Think Tank series.

Q: Why has refinance activity declined and what will bring it back?

A: There are a couple reasons why refinance activity has fallen off:

1. Interest rates have been low for a fairly long period of time. Since June of last year, mortgage rates have slowly started increasing upwards. The rule typically is, as interest rates rise, the refinancing options obviously shrink.

2. The other side of the point is that we’ve had low interest rates for a fairly long period of time, so those who could refinance have already refinanced. I suspect as we go forward in time, mortgage volume will be more and more oriented toward purchases and less and less oriented toward refinance.

Fewer ARMs thanks to QM rules

It’s good news and bad news when it comes to ARMs these days. Historically, before the QM rules came into existence, you would have expected more of an increase in adjustable-rate mortgages. ARM volumes tend to increase when interest rates are rising.

But in this current rising-interest-rate environment, you have to superimpose all the different QM rules. The QM rules require mortgage lenders to be more stringent and require borrowers to be fully qualified, or to be fully qualified at the full index rate. The people who could qualify for an ARM today need to have much better credit and that will limit the amount of new ARMS on the market.

You will see somewhat of an increase in ARMs, but I don’t know if anybody or everybody who can qualify for a 30-year mortgage can actually go out and get an ARM because ARM borrowers are actually qualified at much higher levels just because of the full index rate within an ARM.

Q: Where will new refinances come from?

A: There are a couple of factors which could cause some refinancing activity to come through.

No. 1: The mortgage-yield curve

The mortgage-yield curve is the difference between the different rates of different loan products – the difference between the 30-year rate, the 15-year rate and the adjustable rate. And the mortgage-yield curve is still fairly steep.

You could see some activity occurring from somebody refinancing from a 30-year mortgage to a 15-year mortgage, or somebody refinancing from a 30-year mortgage to a 5/1 ARM.

No. 2: The return of home equity

As the real estate market continues to improve, some homeowners who had much higher-rate mortgages, like seven, eight, nine percent, and could not refinance because they didn’t have equity in their homes, could perceivably refinance as home prices continue to improve or stabilize and their home equity returns.

So as property values increase, there is a percentage – I don’t know how large of a percentage, but a small percentage – that could refinance because they are no longer underwater. But again, that is a function of how well the real estate market performs.

No. 3: The return of private mortgage insurance

There is a resurgence of small private mortgage insurance firms which could lead to more opportunities for borrowers.

Previously, if you had a mortgage loan valuation that was greater than 80 percent of the value of your home, it would be difficult to get a loan. Now, someone with a 90 or 95 percent loan-to-value ratio can get a loan because of the availability of private mortgage insurance.

In general, as mortgage rates increase, you should expect refinancing activity to slow down. If you look at the profits of all the major banks that were recently declared, mortgage volumes are definitely coming down, so the decline of refinance loans is fairly consistent with the rising rates environment.

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