Q: I was offered a mortgage “recast” and I need help evaluating if it is a sound financial move.
My home is worth $250,000. I owe about $68,000, as I have been paying additional principal on the loan. My understanding is that when you do a recast of your mortgage, the lender simply takes the existing balance and adjusts it to the current amortization schedule.
The appeal of having my current monthly payment lowered is attractive in case of a job change or if something happens and I suddenly earn less. I would still pay additional principal and pay off the loan sooner but would have the peace of mind knowing I only owed a lower payment each month.
How do I measure the difference between my payment now and what it would be after a recast in terms of interest paid? All of the online calculators require a lump-sum payment to the principal upfront, so I’m not sure I’m using them correctly.
A: When we have given advice to our readers in the past on refinancing, we’ve told them that there are four factors in what Ilyce calls a “home run refinance.” They are: lower interest rate, lower monthly payment, shorter loan term and affordable fees. If you’re able to achieve all four of these factors, then you’ve got a home run refinance. If you can only get two or three, you might still have a deal worth doing.
Let's start with a lower interest rate. Mortgage interest rates have been rock bottom for the past nine years, or so, and have only risen from 3.5 percent for a 30-year fixed rate mortgage to about 4.5 percent for the same loan in the past year. To put it into perspective, this is still a great interest rate.
So if you can lower your interest rate, that’s good. But you also have to look at your monthly payment. Will your new monthly payment be less than what you’re currently paying? If you’re moving from a 30-year amortization schedule to a 15-year amortization schedule, you may still have a good deal in that you’re saving on the total amount of interest you’re paying, but the monthly payment may stay the same or even rise.
If you're 10 years into a loan and refinance for a lower interest rate, but the new loan will last for a new 30-year period, the lower interest rate will probably not be sufficient to overcome the 10 additional years (beyond the 20 years you have left) of interest and principal payments. That's why shortening the loan term is such a powerful move.
Let's say you have 22 years left on your loan but can shorten it to a 15-year mortgage. The interest rate might be a little less than your current loan and your payments may stay the same or go up. But you'll save seven extra years of payments, which is pretty significant.
The final factor is the cost involved in a refinancing. Frequently we see people refinance a loan to get a lower rate, but the costs of the refinancing outweigh the savings generated by the lower interest rate. For example, if the cost to refinance a loan is $5,000 in fees, but the lower interest rate only effectively lowers the payment by $10, it would take you 500 months to see any benefit in the refinancing. You always want to calculate the return you'll generate on the investment, which in this case is the cost you pay to refinance the property.
As you're doing your calculations, be sure to exclude your real estate tax and insurance payments as you compare one loan with another. Also, be sure to look closely at the principal and interest components of the payment. If you look only at the interest component of both loans, you may see that one loan has a monthly interest payment of $85 and the new loan has an interest payment of $60. In this situation, your benefit from the new loan is lowering your monthly interest payments by $25. That lower interest payment is a good thing.
When you get a one-time mortgage recast, you typically may make a large prepayment and the lender is offering to recast or reamortize the loan for the time you have left. Typically, this doesn't change your interest rate; but because you have a smaller amount of principal, the recasting will give you a lower monthly payment with the idea that you'll pay off the remaining principal balance over the same term.
If there is only $68,000 remaining on the loan balance, but you have 20 years left on the loan term, the lender will recast the $68,000 owed over the 20 years. That should lower your monthly payment quite dramatically.
Typically, lenders don't charge for a one-time recast. So, there's no downside for you. If, however, the lender is charging you to recast your mortgage, then the key issues are the costs of the recast and whether those costs outweigh keeping your old loan intact and continuing to prepay it.
The way you'd figure this out is to put the $68,000 loan into any online calculator and put in the remaining years of the loan term as the actual loan term. This will give you a sense of your monthly payment, which you can then compare to your current payment.
If you then add on the typical amount you’re prepaying each month, you’ll see how quickly the loan will get paid off. Since a recast isn’t a typical refinance, and you probably aren’t paying for it, it’s probably a home run for you.
We hope this helps.
Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact them through her website, ThinkGlink.com.