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Rate Rise Cuts Refi-Eligible Borrowers by Half

NEW YORK ( TheStreet) -- The rise in interest rates has shrunk the pool of borrowers who can refinance profitably by half, according to the latest Mortgage Monitor report from Lender Processing Services.

The latest report offers more proof that the refinancing boom has largely ended. The 100-basis-point rise in mortgage rates since May has led to a sharp decline in refinancing. Prepayment rates have declined 30% over the same period.

Borrowers have less of a financial incentive to refinance when interest rates are rising. Those who still can refinance are those who still pay an interest rate on their mortgage that is high enough for it to make sense -- at least 5% or more. Borrowers not eligible for the Home Affordable Refinance Program need to have at least 20% equity in their homes.

"Over half of borrowers are now 'out of the money' with respect to refinancing," Herb Blecher, senior vice president at LPS noted in his report. "In December 2012, the population of potentially refinance-eligible borrowers stood at roughly 10 million. However, refinance activity during that time, along with rising interest rates, have shrunk that pool to just 5.7 million borrowers as of August."

LPS includes only borrowers with a credit score of over 720 in its calculations of the refinance-eligible population.

Banks have warned that the decline in refinancing volumes will hurt profitability of mortgage operations. JPMorgan Chase (JPM - Get Report), which reports on Friday, has said it expects its mortgage business to report a loss in the third quarter. Wells Fargo (WFC - Get Report) is slashing mortgage jobs in response to the decline in refinancing.

The drop in refinancing volumes is unlikely to be fully offset by a pickup in purchase originations even if banks loosen their credit standards a bit to compete for home loans. In any case, the housing recovery itself is tenuous at the moment, with the rise in interest rates threatening the demand for homes.

One avenue that could open up for banks, however, is home equity loans, according to LPS. "After bottoming out at the beginning of 2012, home prices are now at their highest levels since 2009, and borrowers who bought or refinanced within the last few years are quite likely to have accumulated additional equity in their homes," Blecher wrote. "Based upon LPS' analysis of historical borrowing patterns and home value trends, it is possible that we could see an increase in second-lien borrowing among those who have locked in their first mortgages at very low rates and who wish to tap their equity without refinancing into a higher rate."

LPS also reported mortgage delinquency and foreclosure data for August. About 6.2% of the mortgages were delinquent in August, down from 6.41% in July. The foreclosure inventory rate also continued to decline, falling to 2.66% from 2.88% in July.

-- Written by Shanthi Bharatwaj New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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