Mortgage Recasting 101: How It Works and What It Does

August 30, 2016 No Comments »
Mortgage Recasting 101: How It Works and What It Does

You may have heard that you can lower your monthly mortgage payment without refinancing via a “mortgage recast.”

These two financial tools are quite different, which I’ll explain, but let’s first discuss recasting to get a better understanding of how it works.

In short, a mortgage recast takes your remaining mortgage balance and divides it by the remaining months of the mortgage term to adjust the monthly payment downwards (or upwards). Let’s focus on the downward portion for now.

The downside to mortgages is that the monthly payment doesn’t drop if the balance is paid faster. That’s right, even if you pay more than necessary, you’ll still owe the same amount each month because of the way mortgages are calculated.

So if you made biweekly payments for a period of time, or contributed one big lump sum payment after some sort of windfall, you’d still be forced to make the original monthly payment until the loan was paid in full.

In this case, you could benefit from recasting your mortgage to a lower monthly payment.

Mortgage Recast Example

Original loan amount: $250,000
Mortgage rate: 4%
Original monthly payment: $1,193.54
Current balance: $175,000

Let’s assume you started out with a $250,000 loan amount on a 30-year fixed mortgage set at 4%. The monthly payment would be $1,193.54.

Now let’s pretend after five years you came upon some cash and decided to pay the mortgage balance down to $175,000, despite the amortization of the loan dictating a balance of around $226,000 after 60 payments.

As mentioned, the monthly payment wouldn’t change just because you made an extra payment. Although you owe a lot less than scheduled, you’d still be on the hook for $1,193.54 per month with the $175,000 balance.

The upside is that the mortgage would be paid off way ahead of schedule because those fixed monthly payments would satisfy the lower balance before the term ended.

But suppose you’d like to get your monthly payments lowered to reflect the smaller outstanding balance. That’s where the mortgage recast comes into play.

Instead of refinancing the mortgage, you’d simply ask your current lender or loan servicer to recast your mortgage. This is also known as reamortizing because the original amortization schedule is adjusted to account for that extra payment.

And for a “small fee” (usually), your lender will take your outstanding balance and remaining term and reamortize your mortgage. This fee can range from $0 to $500 or more. You need to inquire with your lender beforehand to determine the cost, if any, as it varies.

So using our example from above, you’d have 25 years remaining on the 30-year loan at the time of the extra payment.

If the loan were recast, the monthly payment would drop to about $924 to satisfy the remaining $175,000 balance over 300 months.

That’s about $268 in monthly savings for the homeowner looking to slow their mortgage repayment, despite making some extra payments early on.

Some lenders may have a minimum amount that you must pay to reduce the loan balance, such as $5,000 or more.

This lump sum payment is made in conjunction with the recast request and you wind up with a lower monthly payment as a result, though the interest rate remains unchanged.

Your mortgage rate is still 4%, but your monthly payment is lower because the extra payments you made are now factored into the remaining term.

It might also be possible to request a recast if you’ve been making extra payments over time and simply have a much lower balance than the original amortization schedule would indicate.

Tip: Generally, your mortgage must be backed by Fannie Mae or Freddie Mac in order to be recast. Jumbo loans may also qualify. It is not an option for FHA or VA loans unless it’s a loan modification.

Also note that you may only be given the opportunity to recast your mortgage once during the term of the loan.

Mortgage Recast vs. Refinance

Alternatively, a homeowner could look into a rate and term refinance instead if they were able to get the interest rate reduced at the same time.

The refinance route could be beneficial because the loan-to-value ratio would likely be low enough to avoid a lot of pricing adjustments.

Let’s say the original purchase price was $312,500, making the $250,000 mortgage an 80% LTV loan at the outset.

If the balance was knocked down to $175,000, and the home appreciated over that five years to say $325,000, all of a sudden you’ve got an LTV of 54% or so. That’s super low.

And perhaps you could obtain a lower interest rate, say 3.50% with no closing costs thanks to a lender credit.

That would push the monthly payment down to around $786, though the term would be a full 30 years again (unless you select a shorter term).

The downside to the refi is that you might restart the clock and pay closing costs. You also have to qualify for the refi and deal with what could be a lengthy underwriting process.

In either case, a lower monthly payment would free up cash for other objectives, whatever they might be. A lower mortgage payment also lowers your DTI, which could allow for a larger subsequent mortgage on a different property.

When a Recast Increases Your Mortgage Payment

As mentioned, there are cases when a recast can actually increase your mortgage payment. These situations occur when you’ve been paying less than what was required to pay off the mortgage by maturity.

Two examples come to mind. One is an interest-only mortgage, which as the name denotes, is the payment of just interest each month.

The interest-only period only lasts the first 10 years on a 30-year mortgage, at which point you’ll need to play catchup to pay the mortgage balance off in time.

Your lender will recast your mortgage after the IO period ends and the monthly payment will be significantly higher to account for the fully-amortizing payment over a shorter, 20-year term.

Another example is a HELOC, where you get a 10-year draw period and 15-year repayment period. It could be some other variation, but once the draw period ends, you must begin repaying the loan.

The loan will recast to ensure monthly payments satisfy the debt by the end of the remaining term.

In both these instances, you can avoid the upward recast by refinancing the loan or paying it off in full before a recast is necessary. You could also sell the property before the recast occurs.

Mortgage Recast Pros and Cons

  • Lowers your monthly payment
  • Reduces your DTI
  • Boosts liquidity for other needs
  • Might be free or very cheap to execute
  • Easier and probably faster than refinancing
  • Can still make higher payments if you want
  • Takes longer to pay off your mortgage with lower payments
  • You may pay more interest if loan is paid more slowly
  • There may be a fee to recast
  • May require minimum lump sum payment
  • Could be more beneficial to refinance to a lower mortgage rate with no cost

(photo: Damian Gadal)

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