Rate Refinancing Is Back in Vogue

The focus of mortgage portfolio risk managers has been squarely on credit in recent months, but they'd better keep an eye on interest rate risk as well.

To the benefit of mortgage servicing hedge professionals, tighter underwriting standards in the wake of the subprime meltdown and housing bust have slowed prepayment speeds. Fewer consumers can qualify for a new mortgage today than could a few years ago, and that is keeping potential refinancing candidates in their current loan, and potential trade-up buyers in their current home. But with rates once again falling below 6% on 30-year, fixed-rate mortgages, all bets are off.

Data from Freddie Mac and the Mortgage Bankers Association suggest that already, interest rate declines are speeding up loan origination volume despite the weak real estate market.

In late November, the MBA found that the Fed's announcement that the Federal Reserve stood ready to buy mortgage-backed securities and the debt of the government-sponsored enterprises, a move that helped push down mortgage rates. The impact was felt immediately, according to the MBA. Economists there said that the average rate on 30-year home loan applications at the beginning of Tuesday, Nov. 25 was 6.06%, but the average fell 29 basis points to 5.77% by the end of the day. Other rate trackers, such as HSH Associates, showed an even larger one-day drop in mortgage rates. Freddie Mac found the 30-year average falling to just above 5.5% in early December, a point that approaches the most attractive financing in recent years for those who can qualify for a fixed-rate loan. Rates are almost a full percentage point below where they were in late October, Freddie Mac chief economist Frank Nothaft noted.

The Fed's intention was to boost home sales and help stabilize housing values, but the move sparked a big increase in refinancing activity as well. In fact, it sparked one of the biggest increases in refinancing activity on record, according to the MBA's weekly mortgage application survey. The refinancing share of mortgage applications rose to 69% during the holiday-shortened week of Nov. 28. While that may be a temporary phenomena, MBA economist Orawin Velz said many borrowers who had been on the sidelines jumped into the market in response to the Fed move to take advantage of the low rates before they rebound. Some remember that rates dropped briefly after the government placed Fannie Mae and Freddie Mac into conservatorship, only to rise again within a few weeks. But at 69% of home loan applications, refinancing is clearly in "boom" territory for the moment. And that means servicing shops, already burdened by heavy default management workloads and struggling to implement streamlined loan modification procedures, now face the additional challenge of managing more portfolio churning than they've seen in some time.

Until now, most economists had been forecasting that home purchase lending volume would be flat in 2009 and that refinancing volume would fall. But the rate drop seen at the end of 2008 may force economists to rethink their projections about refinancing volume in 2009.

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