Mortgage Recasting: When Does It Make Sense for You?
If you’re already a homeowner, or you’re looking to buy a home, you’re probably already familiar with the concept of a mortgage refinance.
But there’s another process that can often be an alternative to a refinance, and that’s a mortgage recast.
A mortgage recast and refinance are often confused with one another, and even discussed interchangeably.
But they’re completely different from one another.
While a mortgage refinance is the more complicated process, that replaces your existing mortgage with a new one, recasting is much simpler, and works with your current loan.
What is a Mortgage Recast?
A mortgage recast is when you apply a large sum of money to your current mortgage balance, in an effort to lower your monthly payment.
But it’s a process you must specifically request before making the large payment.
In a typical mortgage, the lender will apply any additional payments to reduce your outstanding loan balance. This will have the effect of reducing the mortgage term.
- For example, if you have a 30-year mortgage, and you pay off $20,000 in a lump sum, you may chop a few years off your loan at the end of the term.
By contrast, a mortgage recast reduces your monthly payment, but preserves the original term of the loan.
- For example, if you have 25 years remaining on a $250,000 mortgage balance, setting up a recast based on a $50,000 principal payment will lower your monthly payment by about 20%. But you’ll still have 25 years remaining on your loan.
Lowering your monthly payment is the primary reason for doing a mortgage recast.
There are other benefits, and we’ll cover those as we move forward.
How Does a Mortgage Recast Work?
When you recast your mortgage, you’re working with your original loan.
Unlike a refinance, where you replace your current mortgage with a brand-new one, recasting will preserve the interest rate and the term of your original mortgage.
The lender will apply the additional principal payment to the loan in one lump sum.
Most lenders will require a minimum of $5,000 to consider recasting.
Not all mortgages are eligible to be recast.
For example, conventional mortgages funded by Fannie Mae and Freddie Mac are generally eligible for a recast. So are many types of bank funded mortgages, such as jumbo loans. However, the provision does not exist for either FHA or VA loans.
In rough terms, a lump sum payment equal to 25% of your outstanding loan balance will translate into something close to a 25% reduction in your monthly payments.
Lower the monthly payment
A mortgage recast is designed for those who want to lower their monthly payment, without resorting to an outright refinance.
In a typical situation, a mortgage recast will involve a loan that’s current and up-to-date.
However, even if your loan is delinquent, the lender may accept a recast as well.
But the additional principal payment will first be applied toward missing payments, including unpaid principal and interest.
What’s left over after paying the interest will be used to reduce the loan principal, and therefore future monthly payments.
When you do a mortgage recast, you don’t need to be credit qualified, nor do you need a new appraisal performed on your home.
Since the mortgage is already in place, and you’re simply reducing the principal balance, no qualification is necessary.
How Much Does a Mortgage Recast Cost?
One of the major advantages to a mortgage recast is that it’s a lot less expensive than doing a full-on refinance.
While a refinance can involve several thousand dollars in closing costs, recasting your mortgage is done for a small fee.
That’s usually no more than a few hundred dollars.
It’s important to understand that one of the central aspects of a mortgage recast is that you will be preserving the original interest rate on your loan.
If interest rates have risen since you first took the mortgage, this will be a major advantage.
Let’s say you took your mortgage five years ago at 3.5%. If rates are currently at 4%, the recast will enable you to retain the 3.5% rate for the remaining duration of your loan.
What are the Steps to Recast a Mortgage?
Recasting is often confused with refinancing, but the two are completely different animals. Part of the reason for this is that mortgage lenders rarely advertise recasting.
There’s probably a good explanation for this.
While mortgage lenders can earn substantial revenue refinancing your mortgage, they make far less on a recast.
But if you have an eligible mortgage, you simply need to ask your mortgage servicer about the process of recasting.
Unfortunately, even if you have an eligible mortgage, not all mortgage servicers offer a recasting option.
There are several forms you’ll need to complete, which will be provided by the mortgage servicer.
And, as discussed earlier, you’ll need to pay a fee for the service.
The mortgage servicer will then create a new amortization schedule that reflects the additional principal payment, as well as the new monthly payment that will apply for the balance of the loan term.
Benefits of Recasting a Mortgage
We’ve discussed some of the benefits of recasting a mortgage already, but they’re worth repeating here:
Reduces your monthly payment
The most basic purpose of a mortgage recast is to lower your monthly payment.
Doesn’t create a new mortgage
This may be the most under-appreciated benefit of a mortgage recast. Because it doesn’t create a whole new loan, it doesn’t extend the term.
For example, let’s say you’re seven years into a 30-year mortgage. If you refinance, you’ll likely start over with a new 30-year loan. But when you recast, you’ll preserve the remaining 23-year term.
That will give you the benefit of the lower payment, without extending the term.
Costs much less than a refinance
When you refinance a mortgage, you’ll incur closing costs. Those costs are very similar to what you paid when you took your original mortgage.
They typically run between 2% and 3% of the loan amount. If you have a $200,000 mortgage, that can result in between $4,000 and $6,000 in closing costs.
But with a mortgage recast, you’ll pay a fee of a few hundred dollars to complete the process.
That will not only avoid the need to pay the closing costs out-of-pocket, but also the common practice of adding those costs to the new mortgage.
Reduces your interest expense
Even though recasting doesn’t lower your interest rate, the reduced principal balance means you’ll be paying less interest on the loan.
This will be true both on a monthly basis and over the remaining term of the mortgage.
Preserves your current interest rate
This benefit is actually a two-edged sword.
It will work to your advantage if current rates are higher than the one you now have.
But if current mortgage rates are lower than what you’re paying it could be a disadvantage.
You don’t need to qualify
Since you’re merely reducing your mortgage balance and monthly payment – and not taking an entirely new loan – you won’t need to qualify for the change.
The lender won’t run a credit check, verify your income, or even have the property reappraised.
This can be a serious benefit if your financial profile has deteriorated since you took the original loan.
Drawbacks of Recasting a Mortgage
As great as a mortgage recast seems, it’s not without a few drawbacks.
Current mortgage rates may be lower than what you’re paying now
If you’re currently paying 5% on your mortgage, but you can get a new loan at 4%, you might need to seriously consider refinancing your loan rather than doing a recast.
We’ll get into the mortgage-recast-versus-mortgage-refinance debate in the last section.
A recast doesn’t reduce the mortgage term
One of the most compelling reasons to make a large, lump sum additional principal payment on your mortgage is to reduce the term.
When you do, you’ll chop several years off the back end of the loan. That can save you many thousands of dollars by eliminating your payment completely.
A mortgage recast only reduces your payment, not the loan term.
Extra principal paid is trapped capital
One of the disadvantages of home equity is that it’s effectively a dead asset – the equity doesn’t pay interest or dividends.
And you won’t get any more capital appreciation on your home as a result of having a lower mortgage balance.
If you do a mortgage recast, you’ll be increasing the amount of trapped capital you have in your home. That will leave less money for investing or other activities.
When Does a Mortgage Recast Make the Most Sense?
The most obvious answer to that question is:
When you have the funds available to make it happen.
That usually works best when you have a financial windfall.
Receiving a large inheritance is one example. Selling off a major asset, like a business or a second home, is another.
You may decide to use the extra capital to reduce your monthly payment for the balance of your loan term.
And as we’ve already discussed, recasting makes abundant sense when you want to lower your monthly mortgage payment, but you also want to preserve your existing – lower – interest rate.
Mortgage Recast vs. Mortgage Refinance
We’ve loosely covered this comparison throughout this article.
But to recap, a recast is a method by which you apply additional principal to your loan balance to lower your monthly payments. It doesn’t require creating a new mortgage.
Mortgage refinancing is the exact opposite.
You’re paying off your existing mortgage by creating a brand-new one. The new loan will have a new interest rate, term, and closing costs.
When refinancing makes more sense
On the surface, it may seem as though recasting makes more sense than refinancing.
But that’s certainly not the case if refinancing will produce a lower interest rate.
If you’re currently paying 5% on your mortgage, but you can get 4% on a new loan, that will help to lower both your interest expense and your monthly payment.
And even if you do have a large lump sum to pay toward your mortgage, you can include that with your refinance.
For example, let’s say you’re five years into a 30-year mortgage, on which you still owe $250,000. Your interest rate is 5%. You have $50,000 you’d like to apply to the principal balance, and interest rates are currently at 4%.
In this situation, it will almost always make more sense to do a refinance.
By applying the lump sum to the new loan balance, the new mortgage will be $200,000. And it will also carry a 4% interest rate.
That will give you a lower monthly payment from two directions – a reduced principal amount, and a lower interest rate.
Speak to the mortgage lender
If you’re fortunate to have come into a large lump sum and are even considering applying it toward your mortgage, discuss it with a mortgage lender.
Ask the lender to crunch the numbers on both a recast and a refinance.
Which you’ll end up doing could go either way.