Whether your goal is to reduce your monthly mortgage payments or to pay off your mortgage loan early, several strategies can be applied to help you implement your financial plan. Most homeowners are aware of mortgage refinancing whereby a homeowner rebooks their mortgage loan to take advantage of lower interest rates. However, not all borrowers can qualify for a mortgage refinance. A lesser-known option for some borrowers is called a re-amortization or loan recasting.
- A loan recasting or re-amortization requires a borrower to pay a lump sum toward the loan balance, which lowers the monthly payments.
- A loan recast can save on refinancing fees since it doesn't involve a new loan and can be a good option for those credit issues.
- However, when mortgage interest rates are low, homeowners might be better off refinancing versus recasting, even with closing costs.
What Is Loan Recasting?
Loan recasting or re-amortization typically requires a borrower to pay a lump sum toward the balance owed–called the principal–on the mortgage. The remaining payments are recalculated based on the new, lower principal balance, and a new loan payment schedule is created–called an amortization schedule. Essentially, the payment schedule is recalculated to reflect that the mortgage loan now has a smaller loan balance as a result of the principal payment.
Reasons to Recast a Loan
Typically, borrowers choose to recast a loan to reduce their monthly payments. However, some borrowers continue to make their previous mortgage payments and thus pay off their loan sooner. Others use the additional monthly cash flow savings to invest, pay off debt, or save for other purposes.
Another time loan recasting can be valuable is when a borrower is buying a new home before their current home has sold. If a borrower can qualify for the mortgage on the new home while still paying for the previous home, a loan recast can be done. The proceeds from selling the previous home can be used, in part, to pay down the principal on the new home. However, most lenders do not allow a recast until at least 90 days of mortgage payments have been made.
Advantages of Loan Recasting
There are advantages to performing a loan re-amortization or recasting that homeowners should be aware of before refinancing or recasting their mortgage.
Lower Monthly Payment
While paying extra money to your principal balance allows you to pay off your mortgage earlier, the added benefit of loan recasting is that your monthly payments are recalculated to reflect the new balance.
A refinance of a mortgage is somewhat of a misnomer since the process is similar to applying for a new mortgage loan, which includes a new loan application, income verification, and a credit check. For borrowers who cannot refinance because of credit issues or low home equity, a loan recast could be a good option because the borrower isn't applying for a new loan. A typical refinance would involve booking a new loan, changing the interest rate, and the loan term. However, the recast keeps the original loan intact and only changes the monthly payment.
A loan recast can save on refinancing fees since a loan recast doesn't require a loan application. As a result, the closing costs are significantly less expensive for loan recasts versus refinancing. Refinancing fees can cost approximately 2% to 3% of the loan amount. In other words, a $200,000 mortgage refinance could cost $4,000 in closing costs and fees (2% * $200,000). When doing a refinance, the new interest rate must be low enough to recoup the thousands of dollars in closing costs.
Disadvantages of a Loan Recast
However, just as there are advantages to performing a loan re-amortization or recasting, there are also some disadvantages that homeowners should be aware of before making a decision.
Coming up with the money for the lump-sum payment can be quite challenging. Some borrowers simply don't have tens of thousands of dollars in their savings account to use for a principal payment to their mortgage. Also, some financial planners suggest there are better uses for cash than paying down the mortgage balance. For borrowers who have credit card debt, an underfunded retirement account, or lack an emergency savings account, reducing the mortgage might not be the wisest financial choice.
No Change in Interest Rate
Another disadvantage, depending on the mortgage terms, is that a re-amortization will not reduce the loan's interest rate. When mortgage rates are low, homeowners might be better off refinancing, even with closing costs. Some borrowers choose to refinance first, then re-amortize within a year or less to reap the benefits of both financing options.
Paying Off the Mortgage Early
If the goal is to pay off the mortgage faster, borrowers can simply choose to pay extra toward the principal every month, make bi-weekly mortgage payments, or make an extra payment each year. The extra payments over time will reduce the total amount of interest paid over the life of the loan. Also, the added benefit is that the mortgage will be paid off sooner.
Unfortunately, a loan recast is not an option for all types of mortgages. Generally, only conforming Fannie Mae or Freddie Mac conventional loans are eligible. First Time Homebuyer Mortgages or FHA loans and Veterans loans or VA loans cannot be re-amortized. Jumbo loans can be recast depending on the lender, and there are stipulations, including the loan must be in good standing. Also, if the loan has been sold to an investor, the investor must agree to a loan recast along with your mortgage servicer.
Example of Loan Recasting vs. Refinancing
As an example, let's say a borrower is considering whether to refinance their mortgage or recast the loan. The borrower originally had a 30-year mortgage for $350,000 at a 4.25% interest rate with a payment of $1,722 per month.
The borrower now has 15 years left on their mortgage with $240,000 remaining on the loan balance. The borrower is considering refinancing into a 15-year mortgage or recasting the existing loan.
- The borrower pays $40,000 payment toward principal, meaning the new loan balance would be $200,000.
- The monthly payment would be reduced from $1,722 to $1,505.
- The savings from the new monthly payment would be $217 per month.
- The interest rate would remain at 4.25%.
Let's say the new mortgage rate for a 15-year loan is currently 3.20%.
- The new monthly payment would be $1,681 at the refinanced rate.
- Monthly savings would be $41 ($1,722-$1,681).
- Closing costs and fees were $3,000.
- It would take 73 months or six years based on the savings of $41 per month to recoup the closing costs.
If the borrower's goal was to save on the monthly payment and avoid the closing costs of refinancing, it appears that the recast would be the better option. However, the recast costs the borrower more in the long term.
Although the recast provides a lower monthly payment, the interest rate of 4.25% is higher than the refinancing rate of 3.20%. In other words, the total interest paid on the mortgage for the recast would equal $70,820 while the total interest with refinancing would cost $62,504 when the 15-year loan is finally paid off.
Although the recast provides lower payments, borrowers must consider that the interest rate for the refinancing might be low enough to reduce the total cost of interest on the remaining mortgage balance. Also, the refinancing allows the borrower to save the principal payment of the $40,000 used in the recast. Those funds could be invested in a savings account and earn interest for the 15-year period.
When considering refinancing or recasting a loan, a borrower must consider the interest rate savings from the refinance and the closing costs versus the monthly payment savings from the recast along with the money needed for the principal payment.