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Low interest rates are a benefit for home buyers who find it easier to meet lending criteria and have smaller monthly payments. Existing home owners also can benefit from lower interest rates by refinancing their current mortgage. However, some homeowners are not able to take advantage of mortgage refinancing. We recommend that those homeowners consider either recasting their mortgage or making other partial prepayments.
What is Mortgage Recasting?
Refinancing is not the only way a borrower can reduce mortgage payments.
Most consumers are familiar with refinancing, but not recasting. A mortgage recast is a specialized form of a prepayment that allows the borrower to make a lump sum re-payment that the lender uses to reduce the monthly payment.
A great feature of mortgage recasting is that borrowers can reduce loan payments while paying fewer lender fees.
Mortgage recasting is not as popular as refinancing, and all lenders and mortgages do not allow it. Lenders do not advertise mortgage recasting as an option because the fee they earn for a recasting is very small. On average, lenders charge less then $300 to recast a mortgage. Lenders who do allow mortgage recasting sometimes have a minimum amount that the borrower needs to repay in order to qualify.
Even if a borrower has a mortgage with a lender who allows recasting, obtaining approval can still be difficult for some due to securitization. If a mortgage has been bundled and sold as part of a mortgage-backed security, the borrower may need approval from those investors for a recasting. The investors are ultimately the owners of the mortgage cash flows, and a borrower’s prepayment changes the schedule of cash flows those investors receive.
Still, if you are looking to reduce your monthly payments, check with your lender to see if you could qualify for a mortgage recast.
Who Should Consider Recasting Their Home Loan?
Borrowers should consider recasting to reduce their monthly mortgage payments under the following circumstances:
- You can make a lump sum prepayment and want to avoid closing fees.
- You do not qualify for a refinancing because your credit history has some blemishes.
- You cannot qualify to refinance because real estate devaluation drastically reduced your equity stake in the property.
Deciding to Refinance or Recast The Mortgage
Consider a home owner who borrowed $300,000 over 30 years at 5.5%. His current monthly mortgage payment is $1,703.37. After five years he has an outstanding balance of $277,381.60, and he wants to refinance his mortgage at the new rate of 4.5%.
If he refinances into a new 30-year mortgage, his monthly payment will fall to $1,405.45.
The monthly savings, however, does not come without cost. Lenders charge a variety of origination and closing fees for a refinancing just as with any other mortgage. These fees can add up to a couple of thousand dollars.
And, in this example, the borrower also added another five years onto his total repayment period. Unless a borrower signs a 15-year or 20-year loan at the time he refinances, he will be paying for a longer period of time than if he had kept the original mortgage. Those extra payments of interest add up.
Now consider the borrower from the previous example who has $3,000 to spend on refinancing or making a payment on his existing mortgage. Normally what would happen if he made a $3,000 payment on his existing loan is that the payment would not change at all. What typically happens is that the payment would reduce the principal, but not the payment. In this example, the borrower would not reduce his payment but would reduce the number of total remaining payments from 300 to 293.
A mortgage recast, however, does not reduce the number of payments - it is the amount of the actual payment that is reduced. The lender re-amortizes the loan balance over the remaining number of months until maturity. With a mortgage recast, the borrower in this example would have the remaining 300 payments of his loan reduced to $1,684.94.
Recasting vs. Refinancing: The Numbers Compared
Using the information provided in the example above, we find the following:
Total of Payments
$505,962 - before closing costs
$3,000 Loan Recast
$505,482, plus a small fee
This example shows why it is important to check the numbers before deciding how to proceed.
In our example the best result in the long term is to make partial prepayments of your loan. By reducing the number of payments remaining, our fictional borrower saves more in interest cost than a 1% reduction in the loan's interest rate or a mortgage recast.
The downside is that making prepayments means that he had to both (1) take extra money out of your pocket and (2) keep on making the same payment amount (though for less time).
You will need to decide for yourself, based on your circumstances, which transaction makes the most sense.
The Bottom Line
If you are more concerned with reducing your monthly mortgage payment, considering recasting - as it costs less than refinancing and may save you more money over the remaining term of your loan.
If you want to reduce the overall amount of interest you pay over the life of the loan, consider making partial principal prepayments when you can.
But, no matter what, before incurring the time time, cost, and expense, we encourage you to run the same calculations we did in our example. Your unique situation may be different. But before refinancing, recasting, or making a big prepayment, figure out:
- All the costs and fees of the transaction.
- How many payments will be required after the transaction.
- The monthly payment amount.
- The total amount of interest you will incur after the transaction.
- What transaction best meets your goals to (1) minimize total interest payments and other costs and (2) get your monthly payment amount to a level you are comfortable with.