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We usually think of mortgage loans as financing arrangements that can last as long as 30 years. That’s not the case, of course, because mortgages commonly end when homes are sold, refinanced, or the loan is recast.
Wait! Recast? What does that mean? And what’s the difference between recasting and refinancing?
Refinancing vs Recasting
“Refinancing” means we replace an existing loan with a new one, typically to lower monthly costs or to get cash out of the property.
Recasting is different. When a loan is “recast,” we keep the existing financing in place but cut the monthly payment by making a lump sum payment to the lender. Why do borrowers do this? To lower ongoing costs, cut interest expenses, and – often – for the sheer joy of having less debt.
Some readers might be thinking, “wait a minute, who has the cash to make a big lump sum payment to a lender?” As of early April 2023, commercial banks held deposits worth $17.3 trillion.
That’s about $4.1 trillion more than at the end of 2019, just before Covid hit, money that makes recasting now possible for many households.
How to Recast a Mortgage
To see how recasting works, picture a situation where a borrower has a $300,000 mortgage at 6% over 30 years. The monthly payment is $1,799. After five years the balance has been paid down to $278,163.
Over five years a lot of things can happen. Maybe your income has increased, your savings have grown, or along the way you’ve gotten an inheritance or bonuses.
You call the lender and tell them you want to reduce your current loan balance by $25,000. This is called recasting.
If the lender says “okay,” then several things happen. The loan balance falls to $253,163. The 6% interest rate remains in place, but the monthly payment falls to $1,631 based on the remaining 25-year loan term.
The borrower saves $168 per month ($1,799 less $1,631) or $2,016 per year. Additionally, with recasting it may be possible to eliminate the need for mortgage insurance, another monthly savings.
» MORE: See today’s refinance rates
Recasting Pros and Cons
While our example shows how recasting generally works there are a number of pros and cons to consider.
First, the borrower’s $25,000 prepayment is cutting loan costs by $2,016 per year. That can be seen as an 8% return.
This is a “savings” and not “income.” If the need for mortgage insurance can also be eliminated, so much the better. In either case we don’t tax savings, so the real financial benefit is even greater.
Second, lenders should be elated with a recasting request because it means less debt is outstanding and therefore there’s reduced loan risk. However, not every lender will agree to recasting.
For example, you cannot recast FHA, VA, or USDA mortgages. Other loan programs may also decline recasting requests.
Third, the lender may have a recasting fee, perhaps several hundred dollars. However, because the original mortgage remains in place there’s no need for a new closing, new credit check, new tax payments for a new mortgage, a new appraisal, or a new survey.
Fourth, the lender may have a recasting requirement such as a good payment history or a minimum period before the loan can be recast.
Fifth, if the loan allows prepayments in whole or in part without penalty, borrowers can take some or all of their monthly savings and speed repayment of the remaining loan balance.
Lastly, recasting may not be a good financial choice. It might be better to use the money to pay down other debts, those with higher monthly costs or steeper interest rates such as credit cards, student debt, or auto loans.
Should You Refinance Your Mortgage?
Refinancing is an alternative to recasting. Borrowers might prefer refinancing to obtain a lower mortgage rate, obtain cash, get rid of mortgage insurance, or switch from adjustable to fixed-rate financing.
There are two general forms of mortgage refinancing. With a “rate-and-term” refinance the borrower gets a lower rate and monthly costs go down.
Or, there can be a “cash-out” refinance where the borrower increases the loan amount and uses the cash for a given purpose such as paying down debt, starting a business, or bulking up cash reserves.
In practice, rate-and-term refinancing is largely impractical as this is written. The reason is that mortgage rates have risen from an all-time weekly low of 2.65% in January 2021 to rates above 6% in early 2023.
The result in mid-April, according to the Mortgage Bankers Association, is that refinancing was down 57% when compared with a year earlier.
Notice, however, that refinancing did not stop. Borrowers were and are still in the market because cash-out refinancing is in demand.
The reason is that most homeowners have seen property values rise substantially since 2019. With more equity, owners have a new and greater ability to take cash from their homes.
With refinancing, borrowers have closing costs, the need for a new appraisal, and other expenses. As well, they typically cannot take all of their equity from the property.
For example, a home that was valued at $300,000 in 2019 and financed with 10% down ($30,000) plus a $270,000 mortgage. If the property is now worth $445,000, the borrower has roughly $175,000 in equity ($145,000 because of rising prices and $30,000 from the original down payment).
Also, if the original mortgage rate was 3.5%, then the balance after four years is down to roughly $248,000, meaning the borrower has another $22,000 in equity ($270,000 less $248,000).
Add it altogether and the borrower has almost $200,000 in equity.
However, not all equity is available because lenders want owners to have equity in reserve. So, for example, if a lender allows 90% refinancing, the owner may be able to borrow $400,500 ($445,000 x 90%).
In turn, $400,500 less the current loan balance, ($248,000), means the borrower can get about $152,500 in cash from refinancing, less closing costs.
Both recasting and refinancing are strategies mortgage borrowers can use to change their personal economics, and each can be plausible choices for real estate borrowers, depending on their finances and personal preferences. It can pay, at least, to take a look at the options available to you.