By Jennifer Davies
UNION-TRIBUNE STAFF WRITER
The home refinancing mania that has gripped the country has been good for homeowners and the feeble economy.
Homeowners have been able to cut their monthly payments and reap huge cash windfalls by refinancing as interest rates plummeted and housing prices skyrocketed. That "extracted equity," as Fed Chairman Alan Greenspan likes to call the refinancing boom, has spurred additional consumer spending at a time when companies are cutting jobs and other expenses.
In 2002, homeowners converted more than $96 billion of their home equity into cash, propping up the economy through home improvements, car purchases and repayment of consumer debt, said Amy Crew Cutts, deputy chief economist of Freddie Mac, the home loan mortgage company. The refinancing boom has continued into this year, with some $24 billion in equity converted to cash thus far.
"But that has hardly made a dent in the $6 trillion worth of equity value held in single-family homes," Cutts said. "By reducing their mortgage costs through refinancing, homeowners are saving a little more than $110 a month on average, and in aggregate that adds up to some $300 million per month in extra spending money for those homeowners to put back into the economy."
The refinancing bonanza that has kept consumer confidence from cratering could turn into a bust if the housing market cools or the economy further swoons. That could usher in an ugly chapter of high bankruptcy and foreclosure rates.
The nightmare scenario goes something like this: Interest rates rise and housing prices fall. The economy fails to recover and unemployment climbs. Those who have refinanced their homes, taking out cash to pay off credit card debts or purchase new cars, could end up owing more on their houses than they are worth.
Overleveraged homeowners who lose their jobs due to cutbacks would be unable to sell their houses for as much as they owe on them. Unable to make the monthly payments, the overextended consumers could face bankruptcy and even foreclosure.
"My opinion is that everyone is refinancing to death," said Ken Pecus, a real estate agent with California Prudential in San Diego. "People are mortgaging their futures by not paying attention."
Pecus' opinions are shared by many in the mortgage industry and bankruptcy attorneys who see the potential pitfalls of the refinancing boom.
While San Diego's housing market continues to soar, some parts of the country are seeing a stagnation in housing prices and a corresponding increase in foreclosures that could be a sign of things to come.
Indiana is a prime example. According to the National Association of Realtors, Indiana's home foreclosure rate last year was 2.38 percent, more than double the national average. Not coincidentally, the state also has one of the most tepid housing appreciation rates in the country. The Indiana Mortgage Bankers Association reported that Indianapolis' home appreciation rate was 3.71 percent, about half the national average. Indiana has been hit especially hard by unemployment, losing 4.1 percent of its jobs from 2000 to 2002 while the rest of the country lost .9 percent of its jobs.
Already bankruptcies are skyrocketing in some parts of the country, including the East Coast, said Keith Herron, a bankruptcy attorney in San Diego. The number of U.S. bankruptcy filings reached a record in the first quarter of 2003, according the Administrative Office of the U.S. Courts. In the first three months of this year, there were 412,968 bankruptcy filings. The previous record for filings was in Sept. 30, 2002, when there were 401,306 filings.
It's only a matter of time before the bankruptcy phenomenon makes its way to California, Herron said.
"When the bubble breaks – and I'm still waiting for it to happen – there are going to be some very serious repercussions," Herron said.
Not everyone sees the mass refinancing boom in a dark light. At a recent congressional hearing, Greenspan lauded the unprecedented ability Americans have had to turn their home equity into cold hard cash.
"Surveys by the Federal Reserve indicate that equity extraction from homes ... tend to be very significantly employed to repay other debt," Greenspan said, adding that refinancings "have also shown up as a major factor in reducing the burden of consumer debt."
Still, some bankruptcy attorneys and mortgage brokers see clients who look at refinancing cash or home equity lines of credit as free money and are cruising for trouble.
John Yeager of Yeager & Associates/American Mortgage Express said with the huge run-
up in housing prices, people are able to pay off their debts and get tax deductions on the refinancing.
"The problem is that temptation and human nature kicks in, and they run up more debt," Yeager said. "Six months to a year later, they are in the same position."
While Yeager said his clients are fairly responsible, he estimates that 10 percent to 20 percent of homeowners are getting themselves into trouble by misusing the equity in their home.
Ted Grose, president of the California Association of Mortgage Brokers, said the relative ease with which a homeowner can refinance could result in what he calls pyramiding debt.
With all the money flowing from refinancing, there still has not been a significant decrease in consumer debt, he said. A recent report by UBS Warburg found that consumer debt grew by 10 percent in 2001 and 2002.
"You would expect some of that freed-up money would go to pay down debt," Grose said. "The unfortunate consequence is that consumer debt continues to climb."
Mike Philips, San Diego area manager for Wells Fargo's Home Mortgage department, said about two-thirds of the bank's mortgage business is refinancing. Homeowners are refinancing for a variety of reasons: to lower rates, shorten the term of their mortgages or, as Philips put it, "leverage their lifestyles."
The scary part of using home equity to pay off credit cards or make big-ticket purchases is that it converts unsecured debt, which can be erased in a bankruptcy filing, into secured debt in the house, which cannot be written off. If homeowners fall behind in their payments or run into money troubles, that means they can lose their house, said Kerry Denton, a San Diego bankruptcy attorney.
While bankruptcies are down in California, Denton said he expects that could change.
"If something does give and the economy goes bad, you will see the bankruptcy filings go up and more of those people will lose their homes," he said.
The nightmare scenario depends on a significant depreciation in home values. While many believe that the skyrocketing cost of houses in California, and San Diego, will eventually slow down, few see the local market collapsing.
San Diego's economy is not only stronger than most parts of the country, but the region still lacks an adequate supply of housing, said Alan Gin, a professor at University of San Diego's Real Estate Institute. During the 1990s not enough homes were built for the growing population, and it will be a long time before supply and demand come into line. Because of the lack of supply, San Diego's housing market won't be hurt as badly as other regions when mortgage rates do go up.
In fact, Gin is refinancing his own home to bring down his monthly costs.
"The high payment is stressful," he said. "I'm going to reduce it by about $900."
For those who look to reduce payments or shorten the term of their mortgage, refinancing can be positive, said Wells Fargo's Philips.
But the downside of refinancing also can be more subtle, said Pecus, the real estate agent. People who chase after the lowest rates reset the clock on their mortgages, further extending the time it will take to pay off their loans. A mortgage isn't a big deal for someone in their 30s, but when a homeowner reaches retirement age, a big mortgage can be daunting.
"This generation will never pay off their homes," Pecus said.
Philips said there are customers who have refinanced their homes two, three and even four times as rates have fallen to lows not seen since the 1950s. The run-up in housing prices and the low interest rates have caused many in San Diego to view their homes as an investment, Philips said.
That type of thinking could cause problems if the housing market stalls or falls.
"A lot of people are considering their home only as an investment," Philips said. "But you have to look at your home and say, 'I have to live there and be able to afford to live there.' If you do that, you won't get into trouble."
