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Thank you again for the opportunity to appear before this Subcommittee. I would be pleased to answer any questions you may have.

washingtonpost.com: Cash-Outs Let Homeowners Share the Wealth

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Cash-Outs Let Homeowners Share the Wealth
Economists Say Refinancings Have Buoyed the Struggling Economy

By Jonathan Weisman
Washington Post Staff Writer
Sunday, June 8, 2003; Page A01

In the rural northeast corner of lowa, where dairy farmers struggle with plunging milk prices, school budgets are cut to the bone, and unemployment topped out over 9 percent this spring, Michael and Connie Kuennen are plowing more than $100,000 into their century-old farmhouse.

It's not as if Michael, an industrial technology teacher at Turkey Valley High School near Fort Atkinson, or Connie, a human-resource manager, struck it rich in hard times. But like tens of millions of Americans, they have found the silver lining in an otherwise bleak economic landscape: mortgage rates.

Three times in the past year and a half, the Kuennens have refinanced their mortgage, chasing rates on a 30-year fixed loan from more than 7 1/2 percent to a flat 5. That freed up as much as $150 a month and relieved a whole lot of anxiety pressing on their economic state of mind. That, in turn, buoyed the fortunes of the Come and Save Here lumberyard in Lawler, a nearby Home Depot and the carpenter hired to do the custom trim that would preserve the Victorian look and feel of their house.

"We've almost doubled the size of our house, added vinyl siding, a new roof, dormers, custom cabinets, the works," Michael Kuennen said.

Many economists say it is hard to overstate what falling mortgage rates and a boom in refinancing have meant to the nation's struggling economy. They have mitigated the impact of the 2001 recession and helped fuel moderate growth in consumer spending, the principal reason the economy has continued to expand since early 2002.

For many homeowners, fixed-rate mortgages have locked in a financial advantage that will continue long after the economy recovers and interest rates drift upward.

"These effects are going to last for years," said Phil Colling, a senior economist at the Mortgage Bankers Association of America.

Since 2001, banks will have processed more than 271/2 million mortgage refinances by the end of this year, according to the Mortgage Bankers Association. Out of those, homeowners will have converted more than $270 billion of home equity into cash, either to spend or convert high-interest debt into very low interest loans. At least another $20 billion was freed up in lower monthly mortgage payments.

All told, refinancing will have put about $300 billion into the economy since 2001.

Compare that with the tax cuts of 2001 and 2003 that President Bush and his supporters credit with keeping the economy afloat. By the end of this year, the tax cuts will have added $263 billion to the economy. But because that money has flowed gradually to individuals, businesses, and state and local governments, many real estate economists say it has had far less effect on consumer confidence and spending

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In other words, many homeowners say writing a smaller monthly mortgage check makes them feel like they have more money to spend more quickly than complicated and gradual adjustments in their tax liability. Many homeowners typically overestimate how much extra cash they have gained per year by refinancing, multiplying their monthly gain by 12 while forgetting that lower interest payments will also mean a lower mortgage-interest deduction on their tax returns. And at a time when businesses have cut back their spending on payrolls, plants and equipment, it has been consumer spending that has kept the economy going

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"If I lock in a low interest rate and bring down my mortgage $250 a month, that's $3,000 a year I can spend on other things," said Amy Crews Cutts, deputy chief economist at Freddie Mac, who estimated that lower interest costs now save homeowners $300 million a month. "That's a lot more valuable than what President Bush signed into law (last month), and it continues every year that I keep my house."

Overall housing activity, including construction, sales, refinancing, furnishing and refurbishing, usually accounts for 20 percent to 25 percent of the nation's economy, said David Berson, chief economist at Fannie Mae. It now exceeds 30 percent.

"If during the recession of 2001 and the slow growth last year, housing had been more akin to the '70s, '80s, and '90s recessions, the recession would have been severe," Berson said. "And instead of sub-par growth in 2002, we'd be talking about the recession of 2001 and 2002, and maybe 2003."

If anything, the refinancing boom may be heating up again, as homeowners rush to refinance in anticipation of an uptick in rates. Mortgage loan applications and refinances hit record highs the week of May 30.

The resilience of the housing market during the current slow-down is all the more remarkable because it flies in the face of history, said Donald H. Straszheim, a Santa Monica, Calif., economist who has tracked housing's impact on the economy writ large. Most of the post-World War II recessions were exacerbated, if not brought on, by dramatic slumps in the housing sector, and most recoveries have followed a surge in housing activity.

"If it weren't for housing, we wouldn't have had most recessions," Straszheim said. "It's housing that gives the economy its cyclic nature. It goes way down in recession and way back up during recovery."

The opposite happened this time, which is both good news and bad news. Low mortgage rates, refinancing and the rapid rise in housing prices may have kept the economy afloat, but because the housing sector never sunk, it cannot carry the rest of the economy on its back when it rises.

"The bad news is housing never went down, so it's not going to go up," Straszheim said.

For millions of Americans, their houses have been their lifelines. Jason and Andrea Scott entered the economic boom of the late-1990s in a seemingly can't-lose position: two new economics doctorates from Stanford University, a house in San Carlos, Calif., just north of Silicon Valley, and two steady, well-paying jobs at a legal research firm. In 1997, Jason jumped at a chance to join a Silicon Valley Internet start-up. Two years later, Andrea dropped out of the workforce to raise their two young sons.

Then the bottom dropped out of the Bay Area's high-tech economy. Jason's start-up struggled. The family's income began shrinking rather than growing. But the Scotts had their home. They just completed their third refinancing in five years. They were able to convert a 30-year, fixed-rate mortgage to a 15-year mortgage that they will be able to pay off more quickly, yet they pay $100 a month less.

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Better yet, they were able to roll a second, high-rate mortgage into one low-rate mortgage, and even finance their Nissan Pathfinder out of housing equity.

The Scotts are something of a microcosm of the homeowning nation. A recent study by Federal Reserve Board economists found that 51 percent of refinancers who took cash out of their housing equity used it to pay other debts and lower other interest costs. About 43 percent said they had used their cash to make home improvements, and 25 percent used the extra money for consumer purchases, especially cars.

Errol Adels, a Washington-based architect, took out a $50,000 home equity loan to build a $200,000 guest house on his Middleburg estate. He then rolled that loan into a jumbo, $389,000 mortgage that he locked in at 6 percent. His mortgage had gone up, but he has knocked $1,000 a month off his financing

costs.

"With the last tax break, I was supposed to get a check for $300, maybe enough for lunch for two for me," Adels chuckled. "But $1,000 a month, that is a substantial impact."

The Federal Reserve study estimated that between January 2001 and March 2002, mortgage refinancing added nearly $23 billion to consumer spending, or about $18 billion a year through the refinancing boom. That's only about a half percent of total consumer spending, or one-quarter percent of total economic activity, but in an economy on the edge of recession, it's significant, economists agree.

There are also economic benefits far less tangible than a new guest house or sport-utility vehicle. The nearly 72 million owner-occupied houses in the country have seen their average prices climb nearly 16 percent since 2000, to $164,000 from $139,000, according to Norm Miller, director of the Real Estate Center at the University of Cincinnati College of Business. That represents an increase in wealth of nearly $1.6 trillion, and it is through that appreciation that homeowners have been able to capitalize on refinancing

Bruce Hirsh, an employee in the U.S. trade representative's office, has been chasing interest rates for a year. His current, five-year adjustable-rate mortgage on his Dupont Circle home is down to 5 1/4 percent, but he's on the market again.

"No question, when you've got a more relaxed payment schedule, you relax more in terms of how you spend," Hirsh said. "Just psychologically, I can see that I'm just a little less worried."

Many economists struggle to find the downside to all of this. The biggest fear is that it might unravel as quickly as it has unfolded. Much of the rise in housing prices is due to declining mortgage rates, Miller said, estimating that over three to five years, a house's value will climb between 12 percent and 20 percent when interest rates drop from 7 percent to 5 percent.

The fear is that real estate prices will fall when interest rates creep back up, Miller said, especially on the East and West coasts, where prices have been most volatile. Already, a new federal study found, the growth of house prices has slowed sharply over the past year. From the first quarter of 2002 through the first quarter of this year, average prices fell in 13 of 220 metropolitan areas surveyed by the Office of Federal Housing Enterprise Oversight. Average prices rose in the District, Maryland and Virginia.

Another concern is the refinancing boom has enticed Americans to pile up debt by taking on bigger mortgages.

And for all the benefits to long-term wealth of a low 30-year, fixed-rate mortgage, there are potential

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problems. For one thing, homeowners may be reluctant to switch jobs if it means taking on a higher mortgage rate, which could make the labor market less efficient, said Cutts of Freddie Mac.

"If [a mortgage rate) goes to 10 percent, somebody with a 6 percent rate looking at a new job in St. Louis might not take that job," she said.

At this point, most economists studying the issue are sanguine about such prospects. Interest rates surely will creep up, they say, but they won't shoot up. Thanks to the Federal Reserve Board, the days of raging inflation and 18 percent mortgages are behind us, economists say.

Not everyone is so confident. Brad Houser, a real estate broker and developer in lowa City, has ridden the wave as avidly as anyone. In three years, he has refinanced three times, reducing his interest rate from 7.9 percent to 5.87 percent. A month ago, he walked away from his mortgage broker's office with a $100,000 cash-out check, which he promptly put to use to finish his basement and add a few extras to his house above-ground as well.

But he has concerns that the gravy train is coming to an end. His realty business could suffer, as people hunker down with their low-rate mortgages rather than look for new houses. For the next generation of homeowners, who will probably face higher mortgage rates, there will be a great divide, he predicts, "no question about it."

Facing higher rates, young buyers will settle for smaller homes and will need help from the generation locked in under 6 percent, Houser predicted.

He does not know when this will happen, but fretted that when the average rate rises, "it'll go up faster than it ever came down."

© 2003 The Washington Post Company

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