My wife and I are considering downsizing since our youngest recently started college. In the past, we would have arranged to close on the sale of our current house around the time we would purchase the new house. This time, we’re buying first, both to give us an opportunity to update the new house as well as prepare our current house for sale.
In our talks with real estate agents and mortgage brokers, several have mentioned a mortgage recast as something we might want to consider. If you are also unfamiliar with this, here are some points to understand before you move forward.
What is meant by mortgage recasting?
A mortgage recast is when a borrower makes a large one-time payment to the principal balance of their mortgage. As a result, the lender will reamortize the loan. Basically this means that the lender recalculates the remaining monthly payments based on the new, lower outstanding balance.
How it works
There are three steps to the mortgage recast:
- The homeowner makes a payment. Most lenders require $5,000 to even consider a mortgage recast.
- The homeowner pays a fee. Lenders will charge a service fee – usually a few hundred dollars – for the mortgage recast.
- The lender reworks your payments based on the new outstanding balance.
Mortgage recast example
Experian provides a good example of how a mortgage recast would differ from simply making a lump sum payment. Assume you purchased a home in 2016 with a 5%, 30-year fixed rate loan. You currently owe $250,000 and have a monthly payment of $1,600. You received a windfall of $50,000 and decide to put that toward a mortgage recast. Your monthly payment will drop from $1,600 to $1,179 saving you $421.
Of course, there’s another option when paying a lump sum on your mortgage: you could pay off your mortgage sooner. In other words, if you don’t recast your mortgage, the lump sum may go to principal thereby reducing the amount owed so when you make the same $1,600 payment you pay off the loan quicker. The decision becomes do you want a monthly saving for the same number of years or do you want to pay off the loan faster?
Pros and cons of recasting
Pros
Recasting may save you money. If you’re comparing recasting with refinancing your mortgage, you will save money. Refinancing costs run into the thousands while some companies will recast your mortgage for as little as $250.
Recasting will lower your monthly housing payment. If you are having issues making ends meet or perhaps nearing retirement, having a lower fixed-cost for housing could prove advantageous.
Recasting maintains the same rate and term. While you are paying less every month, your interest rate and term remain the same. Your lower payment is based on the lower total loan amount, not on a change in the interest rate or term.
Cons
Recasting may cost you money. Again this is based on what else you would do with your money. If you are comparing a recast to simply sending extra money to pay off principal, you will be paying a fee for the recast. Making an extra payment is usually free.
You may not be eligible. The availability for recasting your mortgage depends on your lender’s policies. Some provide this, others don’t. Additionally, if you have a government-backed mortgage, you cannot recast your mortgage.
You may have other, better options. Having thousands of dollars fall into your lap doesn’t happen often. If you receive a windfall, are there other things you should be using your money for? Have you paid off credit card debt? Are you fully invested for retirement? If it’s a relatively small amount, will it make enough of a difference to warrant recasting the mortgage? Remember, once you put this lump sum toward your house it’s gone (unless you later decide to get a home equity loan). Closely evaluate your options before you take this step.
It always makes me nervous to lock away a large amount of money, especially if there are other uses where it might earn more. If you want to shorten your mortgage, consider making an extra payment every year – just make sure it goes towards principal only. If you are in a situation where you really need to lower your monthly expenses, look closely at your budget to see if you can achieve the same savings by cutting out non-necessities. Even if you decide to recast your mortgage, run the numbers to see the least amount you must lock away to achieve your goals. Quite often, there’s a better place to invest your money.