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Time to refinance?
April 18, 2001: 12:53 p.m. ET

Fed's latest interest rate cut gives homeowners more reason to act
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NEW YORK (CNNfn) - Homeowners who worried they missed their chance to refinance got a new window of opportunity Wednesday as the Federal Reserve Board slashed interest rates by another half percentage point.

The surprise move, the Fed's fourth rate cut this year, buoyed Wall Street, which had not expected an interest rate decision until the next Fed policymaking meeting May 15.

For consumers, lower rates are good news.

Interest rates affect the cost of home loans, car loans and credit card balances, since lenders who borrow from the central bank pass on rate hikes and cuts to customers.

  This gives people who have been waiting on the sidelines over the last few months and have been a little slow to react a bit of a reprieve. This gives them a chance to act.  
  Michael Strauss, AHM  
For homeowners in particular, home equity loans with a floating rate tied to the prime interest rate become more affordable immediately.

Mortgage rates, which are tied to the 10-year Treasury, are not directly affected by the federal funds rate, the overnight bank lending rate that was cut Wednesday to 4.5 percent from 5 percent. Shorter-term loans for cars and major appliances are more closely impacted.

As short-term rates fall, however, longer-term interest rates, including mortgages, tend to follow suit.

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How much can you save?

David Littmann, chief economist for Comerica Bank, said a half-percentage point rate cut translates into a saving of about $34 per month on a fixed-rate mortgage loan of $100,000. Over the 30-year loan period, that equates to a saving of about $12,240.

"What this [interest rate cut] is going to do is to trigger more refinancings," he said. "There were a lot of people who were waiting for a reduction of 1.5 percent to 2 [percentage points] before they refinanced. That's typically what people do."

With Wednesday's Fed action, he said, rates may now drop to a level sufficient to make refinancing worth the average homeowner's while.

Those with a $100,000 30-year fixed mortgage, for example, who are refinancing from a 9 percent loan to a 7 percent loan will see their monthly bills fall from $805 to $665 -- a saving of up to $50,000 over the life of the loan.

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    "That's what most people have been doing since November," Littmann said. "This is the point at which all that refinancing activity and restimulation occurs."

    Others, however, say the old rules of thumb concerning refinancing no longer necessarily apply.

    Common wisdom dictates that you need at least a two-point reduction in the interest rate to make a refinancing worthwhile, but insiders insist that as loan amounts grow larger, reductions of 1 percent and even less can lead to a nice reduction in your monthly bills.

    Michael Strauss, president and chief executive of American Home Mortgage Holdings, a Melville, N.Y.-based mortgage lender, said refinancing activity at his firm began to climb last week, ahead of the Fed's rate cutting move, with applications reaching $161.5 million.

    "That's the highest amount we've seen this year," he said. "These last few days have been confusing for customers, so we were glad to see this rate cut. This gives people who have been waiting on the sidelines over the last few months and have been a little slow to react a bit of a reprieve. This gives them a chance to act."

    Strauss said the process of refinancing itself also has become more affordable.

    The vast majority of refinancers nationwide, he said, choose a zero point loan and benefit from discounts on title insurance. He also notes that the cost of paperwork typically ranges from $400 to $1,000 in most states.

    Will the rate cut trickle down?

    Not everyone believes the latest rate cut will benefit the mortgage industry, however.

    Lawrence Yun, a forecast economist with the National Association of Realtors in Washington, said homeowners waiting for lenders to lower rates in the days and weeks ahead may be setting themselves up for disappointment.

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    "Going forward, I do not think there will be any major decline in long-term mortgage rates," he said. "If anything, there may be a slow creep upwards and the reason is that the Fed action influences short-term interest rates, but the 30-year mortgage will be more influenced by inflationary expectations."

    Those with 1-year adjustable rate mortgages, or ARMs, he said, may see some refinancing opportunities, "but for people on a 30-year fixed rate who are waiting on the sidelines, they may be disappointed in how the mortgage market reacts to this."

    Long-term mortgage rates stood at 8.5 percent last summer and have fallen steadily since as lenders lowered rates aggressively in anticipation of Fed rate cuts ahead. But those cuts have already been priced into mortgage products, Yun said, and now the concern will shift to inflationary expectations.

    "If there is some sign that the economy has turned a corner and is back on track then the opportunity for further rate cuts will be minimal and there will be more focus on inflationary indicators like the consumer price index, or CPI," he said.

    If the CPI climbs in the coming months, as many economists project, 30-year mortgage rates will climb as well.

    A tool for tapping equity

    According to statistics, refinancing is increasingly used as a tool to tap into equity, rather than lower monthly payments. That's especially true as property values soar.

    Freddie Mac's annual refinance review revealed that 59 percent of homeowners who refinanced their loans in 1999 borrowed some of the equity in their homes and surrendered their old mortgage for a new one that was at least 5 percent greater. In 1998, 48 percent of refinancings were for a 5 percent or higher hike.

    In the fourth quarter of 1999 alone, 77 percent of refinances resulted in new mortgages at least 5 percent higher than the original ones. That compared with 45 percent in the year-earlier quarter.

    Freddie Mac's Conventional Home Price Index showed the growth in the value of housing, on a national average, to be about 25.4 percent over the past 5 years.

    Many still, however, refinance for the traditional reasons to lower their monthly payments or lower the life of the loan.

    "You'd want to refinance to either reduce the monthly cost of your mortgage or to reduce the amount of time remaining on your mortgage," Strauss said. "In some cases, you'd actually keep both the payments and loan length the same but refinance to [tap into the equity and pull out some of the appreciated value.]" contributed to this report. graphic