Mortgage Recasting

[Jason]

Until last week when I received a UPS package from the bank, I had never heard of this term or action.

Since we re-fi'd less than two years ago, through aggressive additional principal payments, we knocked five years off of the mortgage. The bank offered to "recast" the mortgage - set it back to its original term by lowering the payments. My question to the mortgage specialist was "If I recast and take the savings and directly apply it as additional principal would I benefit." She said no, so I said no. As it was then just another way for the bank to try to get more interest from me. The lower payment was about $100 per month.

I guess it could be a useful tool if monthly payments are strangling the homeowner.

[Mister Imperceptible]

You may just want to have increased liquidity/future buffer. Which is nice to have, especially if we have a general downturn. But I’m guessing rates are higher now? I would consider this if you retained the same rate after the recast. You could then perhaps pay more into the principal and then recast again in the future, and find an interim sweet spot that leaves you with a super low payment and a nice buffer of liquid funds. Not bad to have if you’re still en route to FI.

[Jason]

With the recast, rate remains as is. Payments are lowered as term is reset.

[Laura Ingalls]

If you don’t incur fees to do this there should be no downside. Just keep paying extra. If you have a cash flow crunch later you can still pay the smaller amount then.

I suspect there are fees though and that’s why they mailed you packet of information.

[Jason]

No fees.

[jennypenny]

If you're paying additional principle every month, lowering the amount of interest built into every payment would increase how much of what you're paying goes towards principle right? (assuming you make the same payments) If so, it seems like a no-brainer.

edit: Check that last part with an amortization schedule. If you're well into your current mortgage, you might end up paying less towards principle if you take the deal since they front-load the interest.

[jennypenny]

A quick look at an amortization calculator ( this one) shows that with a $200K mortgage at 4% (just an example), in year one the interest payment is $679 but in year 15 the interest payment is $433. So recasting could definitely front-load your interest to the point of lowering how much of your total payment goes towards principle, depending on how old your mortgage is.

[Jason]

Bingo. My wife finally got this point through to me this morning.

The recast is not just the term, it's the principal/interest allocation of each payment. Monthly payments and additional principal payments positively impact said percentage. By recasting, you start over.

[Fish]

Are you assuming that you will be making a lower monthly payment after recasting? If you don’t change the payment amount the mortgage will continue amortizing as if the recast never occurred. If the principal (amount owed) and interest rate remain the same, then the recast is only lowering the required monthly payment. The math is only affected by the actual payment made, not what is required by contract. This is the basis of common PF advice such as getting a 30-year mortgage, but paying it off in 15 years. You get the flexibility of being able to make a lower payment in the event of financial difficulties, but retain the option to pay it off sooner.

The no-fee recast offer is a gift from the bank (maybe not one you needed, but still...) provided you have the discipline to continue making payments at the old level.

[Jason]

The recast letter stated that if we accepted the offer, and paid the new monthly amount without any additional principal payments for 30 years, we would pay "x" in additional interest over the next 30 years.

My question to the specialist was "if I take the monthly savings and use it to pay off principal, would I benefit." She said no.

This is my question. For argument sake, let's say my mortgage payment (not taxes and insurance) is now $900.00, $300 of which is applied to principal. If I recast, and the mortgage payment is now $800, is $300 still applied to principal? My understanding is that it's not, that due to recast, principal portion of mortgage payment is reduced. So in affect, if I apply the $100 to principal its not actually an additional $100.00 but is in effect "$100 (-) the loss in monthly principal" due to recast.

So yes, the mortgage payment goes down, but so does the principal paid each month. As I understand it, I am simply financing the same amount of money over a longer period of time at the same rate, so I would have to be paying more in interest even if I apply the monthly savings back into the principal? No?

[jennypenny]

All that matters is how much of the interest you're paying in each payment. If in the current $900, you're paying $400 in interest, but in the recast payment of $800 you're paying $500 of interest (because of front-loading), then the same $900 payment in both cases 'costs' you more if you recast.

If I were the bank and figured out that you were going to pay off the loan early (I'm sure they have algos that do that), then I'd want to net as much interest as possible before you did. I assume the recast is one method they have of securing more money in interest payments.

Not to sound cynical, but why else would the bank do it unless it benefited them?

[Jason]

The only benefit I could see was that the lower payment was now below one (hopefully) future SS payment but that's not our real priority. Our real priority is not to have a mortgage. I agree with your assessment. Recasting benefits the bank or possibly the consumer who needs liquidity, which is of course a dubious benefit.

[Fish]

Let’s make an example. You take out a $200,000 mortgage at 3.5% interest. For a 30 year repayment period (360 months), the monthly payment is about $900. Let’s suppose you make this monthly payment for 6.7 years (80 months), at which time your remaining mortgage principal is $171,685. At present your $900 monthly payment is $500 interest (=171,685*0.035/12) and the remaining $400 goes to principal.

You get a surprise offer from the bank to recast your mortgage to 30 years. The new monthly payment is $770. Because recasting does not affect the principal balance or the interest rate, $500 of your next payment still goes to interest. Recasting changes none of the terms in the blue calculation above. This means you will pay $500 in interest out of your next scheduled payment whether you recasted or not. The reduction in the monthly payment comes entirely out of principal. If you recast, it’s up to you to continue paying the old amount ($900) if you want to follow the old amoritzation schedule and pay the mortgage off in 23.3 years. But recasting allows you to drop the payment to $770 in a pinch.

[jennypenny]

Ok, I see the math works. My bad.

Why would the bank do it though? Banks offered recasting several years ago as part of the TARP program but I thought that ended. Does it make make the bank look better somehow? Does it count as a new refi or customer on their books? Is it easier for the bank to repackage and sell the mortgage?

I guess take it for the flexibility, but it still seems odd to me.

[George the original one]

The bank would prefer you to recast rather than pay off the loan early, since then they have the income stream. I suspect that most people who recast will not work at paying off the loan early, preferring to do something else with the difference in monthly payment (like take out a car loan, potentially with the same bank).

[Mister Imperceptible]

Take the recast and pay ahead anyway. There’s nothing saying you have to make the lesser payment, but there’s no reason not to lower your regular overhead.

It’s not a trick, the banks are reaching for yield. Even if it means lowering the principal payment into the mortgage so you can take out yet another loan.

[Jason]

@Fish - Thank you.

[McTrex]

Essentially we did the same with our mortgage. We took out a 30-year mortgage with a 5-year fixed interest rate. We were planning all along to repay the mortgage within those five years, but if one of the many reorganization rounds in my company were to impact me, we could fall back to a low monthly payment to reduce the cashflow.

As long as you have the discipline to continue making the same payments as you were doing, it’s a good way to reduce your payments in case of an financial emergency.