Homeowners leery of cashing out equity

Mark Alexander is optimistic about his neighborhood and city's economic prospects. So when falling interest rates lured him to refinance his Southwest Center City home today, he might have cashed out some of his equity, as many borrowers did through much of the long housing boom.

But Alexander took a more conservative tack. He and his wife, Sarah Biemiller, replaced their 6.5 percent interest rate with a 5.125 percent 30-year fixed-rate mortgage. Even after rolling in closing costs, they'll save more than $300 a month.

Homeowners such as Alexander, a manager at the Center City District, illustrate the limits facing policymakers hoping to boost the economy by pushing down mortgage rates: Borrowers who have learned from the deflation of the housing bubble are reluctant to again start spending equity - the kind of spending that long helped fuel the broader economy.

The Federal Reserve has gotten at least some of the traction it wanted when it announced plans a month ago to reinvigorate the housing market.

Interest rates are down. Freddie Mac said last week that borrowers paid an average of 5.19 percent for a 30-year fixed-rate mortgage - the lowest since the government-backed corporation started its survey in 1971.

Mortgage activity is rising. The Mortgage Bankers Association said that for the week ended Dec. 12, applications were up 3 percent from the previous week and up 37 percent compared with a year before.

But more than three-fourths of the applications were for refinancing, more than any time in the last five years. And for the first nine months of 2008, Freddie Mac says, borrowers cashed out $99 billion in home equity through refinancings - half of what they extracted during the same period in 2007.

At least anecdotally, cash-out refinancings have become even less popular since the Wall Street meltdown this fall.

"People are scared," said Eileen Marolla, the loan officer at Philadelphia Mortgage Advisors who arranged the mortgage for Alexander and Biemiller. "A couple of years ago, people were pulling cash out like crazy, and adding rooms or adding on third floors. Now the market is way more conservative than I've ever seen it."

Alexander and Biemiller themselves benefited from the rising tide of home prices. In 1999, Alexander bought a house in Queen Village for less than $90,000. Three years later, after investing about $20,000 in improvements, he sold it for nearly $250,000.

But the couple paid a commensurately high price for their next house in Denver, and when they returned to Philadelphia in 2006, they bought near the market's peak. With that in mind, taking out equity wasn't something they considered, Alexander said.

"We know that the house value has probably dropped, so we already have lost equity," Alexander said. "We don't want to take more value out. We still look at our house as one of the biggest assets we have."

It's too soon to say whether homeowners have truly become more conservative about spending home equity. With housing prices faltering - even before the economic meltdown, prices nationally were down 20 percent from their 2006 peak - there may simply be less paper wealth to spend.

"It's hard to say whether people are actually changing their behavior," said economist Mike Zoller of Moody's Economy.com. "Because prices are down, there's less equity to extract."

But at least some economists say a change in psychology would be welcome, even if it means a wave of refinancings won't quickly lift the economy.

Joel Naroff, chief economist at TD Bank N.A., called this year's drop in cash-out refinancing "a fabulous trend" that could be "a necessary and critical part of the correction" the economy needs.

"Right now, the most important thing for households is to get their balance sheets back in shape," Naroff said. "We were essentially making believe our houses were an ATM machine. Now we're recognizing that we want to reduce our debt, not add to our debt."

Improving his monthly balance sheet is Jed Melnick's goal in refinancing his Wyndmoor home.

A lawyer who specializes in mediations, Melnick says he's not worried about his job despite the recession. But rather than drawing on equity, he's looking forward to saving $500 a month by replacing his 6.99 percent mortgage with a 5 percent loan.

"We didn't need it right now," Melnick said. "And if we're learning anything from what's happening right now, it's that we should be careful about what we're spending and building some equity. It seems like people have been overestimating how much they can rely on credit, and living above their means."

Naroff said that a sustained economic recovery depends in part on reaching the right balance, which may require another psychological shift.

"What people are doing now is they're not even spending normally, let alone spending excessively. We want people to get to the point where they're spending normally - spending in a reasonable way and borrowing in a reasonable way. Not saying, 'I've got a lot of money in my house, let me take it out and redo my kitchen.' "