Whether your goal is to reduce your monthly mortgage payments or pay off your loan early, several strategies can help. Most homeowners are aware of mortgage refinancing. But there’s also a lesser-known option called a re-amortization or loan recasting. Here is how it works.
Key Takeaways
- In a loan recasting or re-amortization a borrower pays a lump sum toward their loan balance, which lowers their monthly payments.
- A loan recast will save on refinancing fees since it doesn’t involve a new loan.
- A loan recast can also be a good option for borrowers with credit issues that make them ineligible for refinancing.
- However, when mortgage interest rates are low, homeowners might be better off refinancing instead of recasting, even with the added closing costs.
What Is Loan Re-Amortization or Recasting?
Loan re-amortization or recasting involves the borrower making a lump sum payment toward their current mortgage balance. The lender recalculates the remaining payments based on the new, lower balance and creates a new amortization schedule for the loan. Because the balance is now lower, the monthly payments will be, as well.
Reasons to Recast a Loan
Typically, borrowers choose to recast a loan to reduce their monthly payments. However, some borrowers will pay the lump sum, then continue to make the same monthly payments as before as a way to pay off their loans sooner. Others might use the additional disposable income to invest, pay off debt, or save for other purposes.
Recasting might also be the only option for borrowers who want to reduce their monthly loan payments but wouldn’t qualify for refinancing because of credit issues.
Advantages of Loan Recasting
A loan re-amortization or recasting can potentially benefit homeowners in several ways.
Lower Monthly Payments
When you recast your mortgage, the lender will recalculate your monthly payments, which will now be lower. You can use the freed-up cash for whatever purpose you wish.
No Credit Issues
Mortgage refinancing is somewhat of a misnomer since the process is similar to applying for a new mortgage. That typically includes a new loan application, income verification, and a credit check. For borrowers who cannot refinance because of credit problems or insufficient home equity, a loan recast could be a good option because they aren’t applying for a new loan.
A typical refinance involves a new interest rate and often a new loan term. However, the recast keeps the original loan intact and only changes the monthly payment.
Lower Fees
A loan recast can save on fees since it doesn’t require a loan application. As a result, the closing costs are significantly lower for loan recasts versus refinancing. Refinancing fees can cost approximately 2% to 3% of the loan amount. In other words, a $200,000 mortgage refinance could cost at least $4,000 in closing costs and fees, while the fees on a recast are unlikely to run more than a few hundred dollars. For refinancing to be worthwhile, the new interest rate must be low enough to recoup the thousands of dollars in closing costs within a reasonable period of time.
Disadvantages of a Loan Recast
However, a loan re-amortization or recasting can also have some downsides.
Lump-Sum Payment
Coming up with the money for a significant lump-sum payment can be challenging for many of us. Some borrowers simply don’t have extra thousands of dollars lying around.
Also, some financial planners suggest there are better uses for cash than paying down a mortgage balance. For borrowers who have high-interest credit card debt, an underfunded retirement account, or no emergency fund, paying down their mortgage might not be the best financial option, especially if the mortgage has a relatively low interest rate.
If your goal is to pay off your mortgage faster and you’d have trouble coming up with a lump sum, simply paying a bit extra toward the principal each month is another—though possibly slower—way to go about it.
No Improvement in the Interest Rate
Another disadvantage, depending on the mortgage terms, is that a re-amortization will not reduce the loan’s interest rate. When mortgage rates are low, homeowners might be better off refinancing, even considering the closing costs. Some borrowers choose to refinance first, then to re-amortize within a year or less to reap the benefits of both financing options.
Not All Mortgages Are Eligible
Unfortunately, a loan recast is not an option for some types of mortgages. Generally, only conforming Fannie Mae or Freddie Mac conventional loans are eligible. FHA 203(k) loans and VA loans cannot be re-amortized.
Jumbo loans can sometimes be recast, depending on the lender. Also there may be stipulations. For example, if the loan has been sold to an investor, the investor must agree to the recast, as well as the mortgage servicer.
Example of Loan Recasting vs. Refinancing
Let’s say a borrower is considering whether to refinance their mortgage or recast it. The borrower initially had a 30-year mortgage for $350,000 at a 4.25% interest rate with a payment of $1,722 per month.
The borrower now has 15 years left on their mortgage with $240,000 remaining on the loan balance. The borrower is considering refinancing into a new 15-year mortgage or recasting their existing loan.
Recast
- The borrower pays $40,000 toward the principal, so the new loan balance would be $200,000.
- The monthly payment would be reduced from $1,722 to $1,505.
- The savings from the new monthly payment would be $217 a month.
- The interest rate would remain at 4.25%.
Refinance
Let’s say the new mortgage rate for a 15-year loan is currently 3.20%.
- The new monthly payment would be $1,681 at the refinanced rate.
- Monthly savings would be $41 ($1,722 – $1,681).
- Assuming closing costs and fees of $3,000, it would take 73 months, or a little over six years, to recoup the closing costs.
Comparison of the Two
Suppose the borrower’s goal was to save on monthly payments and avoid the closing costs of refinancing. In that case, it might seem that the recast would be the better option. However, the recast costs the borrower more in the long term in this example.
Although the recast provides for a lower monthly payment, the interest rate of 4.25% is higher than the refinancing rate of 3.20%. Consequently, the total interest on the recast mortgage would exceed interest for the refinance when the 15-year loan is finally paid off. The recast interest would equal $70,820, while the total interest with refinancing would be only $62,504.
What is more, the refinancing allows the borrower to save the extra principal payment of $40,000 used in the recast. Those funds could be invested and earn interest during those 15 years.
What Credit Score Do You Need to Re-Amortize or Recast a Mortgage?
Your credit score should have no effect in your ability to re-amortize or recast your mortgage, since you are not applying for a new loan.
What Credit Score Do You Need to Refinance a Mortgage?
While lenders differ, you’ll typically need a credit score of at least 620 to refinance. A higher credit score can mean a lower interest rate.
How Large a Lump Sum Do You Need to Recast a Mortgage?
Lenders will vary, but in most cases you’ll need to make a lump sum payment of at least $50,000. There are also some costs involved but they’re usually modest, such as a few hundred dollars or less.
The Bottom Line
Recasting or re-amortization can make sense for some homeowners with mortgages. However, refinancing may be a better option of interest rates have fallen and the borrower has good enough credit to qualify for a new loan.