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.
- 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 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 insure on-time payment. 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.
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 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.
Example of Recast Trigger
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.