Wednesday, October 8, 2008

Refinancing vs. Recasting Your Mortgage

I've tried a few times over the last year to refinance our mortgage at a better interest rate than the one we've got. A few times it seemed like it was going to happen, but for a variety of reasons it hasn't, even though our credit rating is excellent and we've proved ourselves good risks on this mortgage.

My most recent conversation was with our wonderful bank, USAA. (If you're eligible for their services but not using them, you really need to look into doing so. You'd be nuts to pass up this much value and genuine customer service.) During the course of the conversation I had with the loan officer, he mentioned recasting a mortgage, which was something I'd never even heard of. It turns out that recasting a mortgage is a pretty standard practice, if not so well known or widely available as refinancing.

Disclaimer: I am not a financial advisor or professional in any way. Speak to a qualified expert for more infomation rather than relying on what I'm about to say here.

Recasting can mean a few different things, but here's how it would most commonly work. Say you've had a mortgage for a few years, and during that time you've been a good little frugalite and have made extra principle payments each month. Or, you've taken a sizeable windfall in the form of a bonus, inheritance, or whatever, and applied it to your principle. In other words, you're ahead of schedule in repaying your loan. At some later point, either because of unemployment or some other financial difficulty, your budget changes and you want to reduce your required monthly mortgage payments. By recasting your mortgage with your current lender, the term of your mortgage and your interest rate will stay the same, but the loan is re-amortized to give you smaller monthly payments so that you will pay off the loan exactly according to the original term of the loan.

Got that? Let's say it again so that we're clear on the concept. You're five years into a 30-year mortgage, but you've been paying ahead. If you keep up the extra payments, you'll retire the mortgage 12 years ahead of schedule. But suddenly you can't make the regular payments very easily anymore, let alone pay extra. If you are able to recast your mortgage, your monthly payments go down. If you stick to that lower monthly payment, you'll pay off the mortgage exactly on the original 30-year schedule.

Why do lenders sometimes offer this? Because it works for both the lender and the borrower. Because you've paid off part of the mortgage ahead of schedule, either with those extra monthly principle payments or with one lump-sum paydown, you've shown yourself to be a pretty good risk, but a low return. Look at it a little more deeply from the lender's perspective. By lowering the monthly payment and keeping the original term of the loan, the lender stands to gain more over time, as opposed to having the borrower pay off the loan quickly and paying less interest in the bargain. More concerning to the lender is the issue that if you, as a borrower, are asking for a recast of the mortgage, you may now be in the market for a refinance from another lender. Worse yet, if the borrower's financial circumstances have changed, he or she may now be at risk of defaulting. Financial institutions don't like defaults on loans. As a lender, it makes sense to work something out that keeps the borrower paying, accepting smaller monthly payments, but making more money over the long run. It's a win-win situation if the borrower is in dire straits.

This is interesting to me as a mortgage holder who has been making substantial extra principle payments. The traditional argument against early repayment of a mortgage is that it's better to invest the money and earn a higher rate of return. (Well, I think we all know just how far out the window that idea has been tossed lately.) But the recasting of a mortgage looks to me like a sort of unofficial safety net for people who have their financial house in order and want to aggressively attack their debt. If you throw every extra dollar at your mortgage and make a significant dent in it, you're essentially putting yourself on a good footing to ask for a recast if your finances take a turn for the worse.

My understanding is that not all lenders offer recasting of mortgages. From what I've heard, if it is available to you, it should cost significantly less in fees than a refinance. Something in the hundreds of dollars range, rather than the thousands of dollars range.

I wouldn't recommend paying down mortgage principle instead of building up a cash savings emergency fund. But it's nice to know that our early repayment efforts give us a good chance at that latitude if need be. I'm not sure why I never heard of this before, but I'm glad I know about it now.

16 comments:

crgilvr said...

USAA is the best. It's wonderful to be banking with them in these scary times. I have everything consolidated under one dashboard except for a single high-yield ING account.

el said...

Thanks for the info, Kate. I had USAA for my first car loan: they even negotiated what I wished to pay from the dealer, they were great! But this is good news too about recasting. We've been here only 4 years but we intentionally bought a cheap house (and fixed it up ourselves with cash) at a great rate on a 20 year term. We have been making 2 mortgage payments a month, and paying something like 1.5x the standard payment per month (again, cheap house, cheap mtg) but we wonder what'd happen if the other shoe really drops in this financial crisis. So...good to know! Thanks!

Loving Annie said...

After paying down 100k in principal, I did a recast with BofA a year or so ago, and it really helped.

They charged me $250 dollars to do it.

Banks don't normally tell people about this as an option, which is a shame.
Reducing my monthly payments made life much easier.

AG said...

To: Loving Annie
I have a mortgage with BofA, and contacted them recently about recasting my principal.
The office manager called back saying that he has never heard about recoasting (he has 20 years of experience) and he said that he contacted Customer Service and they did not help him. He ofered me refinancing, which I do not want to do.
I have read in many Blogs that people do recasting, but I do not know what to next, who do I need to contact, if my local BofA officer does not help.

jwashkau said...

AG,

Call the BoA recast dept @ 1.800.405.0077 from 8a-5p EST M-F. If you have issues call their Customer Service Dept @ 1.800.669.6607.

Hope this helps,

Jesse Washkau

Anonymous said...

I am 10 years into a 30 year fixed mortgage. I should be on payment 12o of 360 but because I've been making extra principal payments each month I am on payment 199. I called CCO Mortgage and asked about recasting my mortgage and they were very helpful. Much of the article talks about recasting to lower your payment in case of financial trouble. My plan is to recast and continue my same level of payments...in essence paying down the principal balance even faster. Am I missing something?

Jeff in MA

Kate said...

Jeff, the answer isn't clear to me, but I think you had better look at the numbers carefully. One effect of recasting your mortgage is that a smaller proportion of each payment goes to reduce the principle. You'd need to check on your particular case, but you might well be better off just continuing to make extra payments with your standard monthly payment.

Peter said...

I just stumbled upon this site and I am happy I did.

And yes, USAA is the best and they have recently expanded eligibility options; so if you have served honorably and/or have relatives that are USAA members, you are eligible.

Laura said...

Kate's comment above may answer my question - I was wondering if recasting will disadvantageously change the percentage of my payments going to principal? I am about 1/2 way through a 15-year mortgage, and I have been liking it that for a long time, more of my payments have been going to principal than interest...
Anyone know any more about how recasting affects the percentage of subsequent payments going to principle?? Thanks

Kate said...

Laura, yes, that's exactly what recasting does - it lowers the percentage of your payment that's going to principle. The main (only?) reason to do a recast is to reduce the monthly payment. It's a tool that makes sense if your cash flow from month to month is reduced.

Madelyn said...

YOU JUST SAVED ME! I'm planning on retiring in a few years but my biggest worry is my monthly mortgage payment. I never heard of "Recasting" before until yesterday when talking to BofA about a re-fi. The loan officer mentioned doing a recast at the very end of our conversation yesterday. I told him I'd research and make my decision soon. After finding your blog I've made up my mind. I now know I can retire on schedule and do just fine. Thanks from the bottom of my heart.
Madelyn
Grandmothersontherun.com

Kate said...

Madelyn, glad I could help.

sarah said...

Thanks for the blog.I am 20 years into a 30 year fixed mortgage.I should be on payment 100 of 360 but because I've been making extra principal payments each month I am on payment 199.
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Mortgage Calculators

Anonymous said...

If you are in the first year of a 30 yr mortg. and make a LARGE payment towards principal(approx. 70% of loan) should recasting or refinancing be considered or just continue with payments as originally set up? Never sent more than required just have windfall to apply. Thanks for any input.

Kate said...

Anon, you should speak with a professional financial consultant. But in a nutshell, the question is whether you prefer to have a lower monthly mortgage payment, or pay off your loan sooner. If locking in a lower monthly payment is more important to you, recast. If getting out of debt faster is more important, leave the mortgage alone and your payments will pay off the principle way ahead of schedule.

Susanna said...

I understand that recasting reduces the percentage of each mortgage payment that goes towards the principal and that its only advantage is a reduction in the monthly mortgage payment. However, I am wondering if it doesn't have the added benefit of improving your debt-to-income ratio. Someone who wishes to buy a second property, for example, may have too high a debt-to-income ratio under the higher mortgage payments for the bank to loan the money. By lowering the monthly debt substantially, that individually would probably qualify. Or am I wrong in thinking this? I am considering a recasting for this very reason only and would welcome advice, since I plan to continue to make large extra payments towards paying off the mortgage anyway.