Is recasting your mortgage right for you? Do you know what it is, and how to request one from your lender?
Now that I firmly planted my foot in the land of the unfree with a fresh new mortgage, I set out to see if there are any quick and painless ways to reduce the monthly mortgage payments. While I was speaking with my lender over the phone, we talked about a loan recast, where my lender can lower my monthly payment for no cost.
No, not a refinance. A loan recast to lower your mortgage payment with no upfront costs.
What is a Loan (Mortgage) Recast
A loan recast is just a fancy term for re-amortizing your loan schedule with the remaining terms of the loan. Here’s how it works.
Let’s say you got a 30 year fixed mortgage for $500,000 at 5%. Plugging the numbers in a calculator, you get a monthly payment of $2,684.11. If you paid every monthly payment on time and at the same amount as required, you’d have $406,710.32 outstanding after 10 years.
Re-amortizing the balance for 20 years at this point gets you the same monthly payment of $2,684.11 since the remaining length of the term is still the same. No surprises there.
Now consider this alternate scenario. Let’s say that after 10 years, you got a windfall of $20,000 and decided to put it all towards the principal of the loan. The resulting loan balance would be $386,710.32, but due to how the mortgage system works, your monthly obligation would still be $2,684.11.
However, the situation changes if you request a loan recast with your $20,000 payment. Because your remaining balance is lower now, your re-amortized monthly payment becomes $2,552.12, quite a bit less than the original.
Benefits of a Loan Recast
Remember that a loan recast only lowers your monthly obligation, and is not the maximum that you can pay towards your mortgage. Once your monthly payment is lowered, you can still pay your original amount and have the extra money go towards your principal.
For the disciplined, this could be a wonderful option to increase flexibility without added costs. Remember, a loan recast doesn’t cost you a thing.
Caveats of Recasting Your Mortgage
Though I hear that many lenders will do it, none are required to recast your loan. If this interests you, check with your lender to see if this is even possible. Also, most lenders require a substantial minimum payment towards the principal to honor such requests (during my research, I read the $5,000 minimum quite a few times). So again, check with them first before you make any plans.
Also, make sure, and this is ultra important, to ask yourself whether this makes sense for your own situation.
Recasting a mortgage lowers your monthly obligation, but you are paying for this privilege with possibly more valuable liquidity. With riskfree returns at all time lows and so many people out of work, I see this being beneficial for people who have ample cash reserves and just want to pay less interests over time.
Also, flexibility always comes with responsibility. Does a lower payment just give you an excuse to spend more? Times are tough and a lower obligation makes quite a bit of sense right now, but remember that this reduction is permanent for the remainder of the loan. When normal times are back, are you then going to put in a higher amount to pay the loan down faster? Or is the extra purchasing power going to mean more shoes in future months?
David, Why Not Just Refinance?
That’s a great question. It’s probably why no one ever talks about recasting mortgages because with rates so low, practically everybody who has a home loan can simply refinance their mortgage to lower their monthly payment. Don’t forget, though, that refinancing costs money, as the fee is simply added to the total amount owed. At the end of the day, refinancing pushes the day you become debt-free further out.
Recasting, on the other hand, is quite the opposite. People interested in a loan recast should want to become mortgage-free sooner. The maneuver simply gives them more flexibility by having a lower required monthly payment, should they need the leeway in the future.
Lenders are also tightening lending standards these days. Lower rates sound great, but some people who are asset heavy with not much income, like small business owners, freelancers, and well to do savers who were recently laid off may not qualify for a new loan. A loan recast may help these groups of people pay less interest over time.
For example, a well to do saver who’s just been laid off may have $100,000 sitting around an online savings account earning 1.5% while paying 4% on a mortgage. That $100,000 may be very valuable for someone who just lost his income, but it may not be depending on his overall financial picture. The person is married, and their family can easily live on one income. His wife is also working in an industry that’s unaffected by the recent downturn.
They also made several large principal reduction payments in the last few years and never realized they can lower their monthly obligation.
By taking, say, $5,000 from their six-figure cash pile to pay down the loan even more, they may be able to substantially lower their mortgage payments by requesting a mortgage recast.
As you can see from the example above, recasting could make sense for some people.
Is a Loan Recast in Your Near Future?
So, what are you waiting for? Are you already looking up your lender’s phone number? Call the servicing company up to get a no-cost monthly payment reduction. I know I would be if I haven’t heard of this before and have unneeded cash lying around earning next to nothing. I would still plan to pay the original amount, but the lower payment may become useful later on.