What Is a Recast Trigger?
A recast trigger is a clause in a loan contract that sets into motion an unscheduled modification to the loan's remaining amortization schedule, such as its repayment table, should certain conditions be met.
- A recast trigger is a clause in a loan contract that can result in an unscheduled modification to the loan's amortization schedule.
- Risks associated with recast triggers include unscheduled adjustments that may increase payment terms substantially.
- Borrowers should familiarize themselves with the risks associated with a recast trigger because it may cause financial distress.
Understanding a Recast Trigger
Recast triggers should not be confused with a mortgage recast. In the latter, an amortization schedule is recalculated and adjusted based on changes in principal payments. For example, a mortgage may be recast if the principal amount is partially prepaid.
A recast trigger essentially changes the scope of the amortization schedule so as to ensure on-time payments. In particular, the clause speaks to negative amortization mortgages. By definition, a negative amortization occurs when the principal balance of a loan increases because a borrower failed to make payments that cover the interest due.
The remaining interest owed is added to the loan's principal. When the mortgage's outstanding principal balance rises to a certain percentage, typically between 110% and 125% of the mortgage's original principal balance, the trigger takes effect and the recast becomes effective.
Negative amortization can occur with certain types of adjustable-rate mortgages (ARMs), including payment-option adjustable-rate mortgages. These mortgages allow borrowers several different ways to pay off the mortgage, such as paying all of the principal and interest, paying only the interest, or paying only some of the interest. While the borrower may appreciate the different payment options with an option ARM, the borrower could wind up paying more over the long term.
Recast Triggers and Risks
A recast trigger presents certain risks that borrowers should familiarize themselves with as they engage the mortgage application process because a lack of understanding could create real financial distress.
When a payment-option adjustable-rate mortgage hits its negative amortization limit and triggers an unscheduled recast, the monthly payment is likely to increase substantially, resulting in payment shock.
The affordable payment that the borrower paid could turn into a significant financial burden should the rate on the ARM adjust and require a larger monthly payment. In an extreme scenario, the payment could increase to the point where the borrower has no choice but to default on the debt.
Before taking on an adjustable-rate mortgage (ARM), make sure that you can afford the mortgage if the interest rate kicks up, which increases the mortgage's monthly payments.
Notably, even a modest rise in interest rates, depending on the level of the negative amortization limit of the mortgage, could cause an unscheduled recast several months before Month 61, which is typically the first scheduled recast on a payment option ARM.
It is a standard operating procedure for an option ARM loan to recast every five or 10 years, so Month 61 is a significant marker along the way toward loan repayment. That is when a new minimum payment is calculated. It is to be paid in Month 61 based on the fully indexed rate, the remaining term of the loan, and the loan balance at that time.
Recast triggers are most commonly associated with loans that are tied to adjustable rates. This is primarily because the trigger clauses allow for changes to the loan's timeframe and payment schedule.
For example, if a borrower has a 10-year ARM loan and misses a couple of payments, then the recast trigger helps readjust their payment schedule and amount.
Similarly, if the interest rates keep on rising even as the borrower makes the minimum required amount payment, then the negative amortization limit kicks in and the borrower may be on the hook for penalty payments.
What Does It Mean to Recast Your Mortgage?
A mortgage recast is when a borrower with a mortgage pays a large sum of money towards the mortgage and the lender then recasts the loan. Recasting the loan refers to re-amortizing the loan, which results in reduced monthly payments due to the new reduced balance. Recasting your mortgage can save you money over the long term.
What Causes Negative Amortization?
Negative amortization occurs when the borrower of a loan makes payments that are less than the interest owed. This results in an increase in the loan balance as the unpaid interest costs are added to the loan. Upon the maturity of the loan, the borrower may have to make larger payments due to the increased size of the loan balance.
Does Mortgage Recasting Reduce Your Interest Rate?
Mortgage recasting does not change the terms of your loan, which includes your interest rate. Your interest rate remains the same. A mortgage recast only changes your amortization schedule due to the fact that your principal amount has been reduced after a lump sum payment was made. Your monthly payments will be reduced and you will pay less interest over the remainder of your loan term.