Subprime Refinancing: Equity Extraction and Mortgage Termination

Abstract

This article examines the choice of borrowers to extract wealth from housing in the high-cost (subprime) segment of the mortgage market and assesses the prepayment and default performance of these cash-out refinance loans relative to the rate of refinance loans. Consistent with survey evidence, the propensity to extract equity is sensitive to the relative interest rates of other forms of consumer debt. After the loan is originated, our results indicate that cash-out refinances perform differently from noncash-out refinances. For example, cash-outs are less likely to default or prepay, and the termination of cash-outs is more sensitive to changing interest rates and house prices.