There is a huge debate in the personal finance space as to whether paying down your mortgage in advance is a good or bad thing to do for your long-run financial success. From my perspective, it doesn’t really have to be such a heated argument as there is room to have benefits to both sides. When it comes to your mortgage being paid down in advance, many people forget that there is a mechanism in place that all banks have that enables you to lower your monthly mortgage payment called recasting. You can save on your mortgage payments monthly with little to no cost.
Recasting is the process of extending your loan out to its original length and reducing your monthly payments at your current interest rate by the amount you’ve paid down in advance. Some people have chosen to pay down some of their mortgages in a lump sum and some people choose to make regular advance payments on the mortgage. Whichever way you’ve chosen to make these advance principal payments, you’ve paid down your balance and when recasting, you usually can expect about a $5 reduction in your mortgage payment for each $1000 paid off in advance (mortgage rate dependent), but we’ll cover the specific math below.
How is recasting different than refinancing?
This is the first question on peoples minds when they first hear of recasting. The most simplistic answer is that recasting keeps the same rate you currently have and uses your existing loan to modify its term. Refinancing on the other hand is a completely new loan that is used to replace your current mortgage with a new rate.
Financially, it makes a lot of sense to refinance when you’re getting a lower rate on your mortgage, but most people don’t advise doing so unless you can land a rate that is roughly 1% lower than your existing rate. One other difference between recasting and refinancing are the fees. Refinancing generally has higher fees associated with it while some banks allow recasting for free or for a low fee of several hundred dollars.
How do you recast?
To recast, all you need to have done is pay down some of the principal on your mortgage loan in advance of starting the process. Before you pay anything to the bank in advance, you should call your lender to see what stipulations they have for recasting. Even if you’re not thinking of recasting right now, go call your lender. It’s really important to have the details from your lender before you need to recast for any reason as their requirements may limit your ability to do so.
So, what are the limitations that you may run into? Banks sometimes require that you’ve paid a certain amount of principal down in advance, for instance, they may want you to have paid down an extra $5000 before they can recast your loan. While others may want you to make a large payment to the principal as a part of recasting regardless of whether you’ve made advance payments automatically every month for years. These can both be hard limitations to overcome if you’re suddenly put in a position where you need to lower your monthly mortgage payments as fast as possible.
Once you call up your bank they’ll provide you the details of how much your new mortgage payments will be once you perform a recast on your loan. Sometimes this number can be substantial. In my cast, I’ve paid my after-tax bonuses into my mortgage every year for the past 2 years. If I were to recast, I would lower my monthly payments by roughly $300/mo. However, I’ve paid a lot of money into the mortgage in advance to make it possible for me to save on my mortgage by that much.
Some other important reasons to call your bank and ask about recasting limitations are that not everyone can recast. FHA & VA loans don’t allow for recasting in general and jumbo loans can’t be recast across all lenders. Additionally, sometimes there are fees associated with recasting.
What does recasting cost?
This really depends on your lender. My mortgage is owned by CitiBank and recasting with them, the last time I checked in April of 2020, was $0. Other banks charge relatively limited fees in the hundreds of dollars to recast.
The banks ultimately want you to recast because one very important thing happens to your loan pay-down amount when you recast: the bank makes more money on the interest of your loan when you extend the term. Their interest rates have more time to compound v. you paying off your loan in advance.
How much will my mortgage payment be reduced?
You’re likely wondering how much this will actually impact you as a mortgage holder if you do it. There is a general rule of thumb mentioned earlier in this article that recasting can lower your monthly payments by $5 per $1000 you’ve paid into the principal of the loan in advance. While this is a good rule of thumb, you probably want to know the exact amount you’ll be paying out each month.
For that I recommend jumping over to Google’s free mortgage calculator to quickly compute how much your future payment will be if you recast.
Let’s take my specific situation. Currently, I pay $1,812 per month for my mortgage but have only $328,000 remaining on my mortgage balance at a rate of $3.675. Were I to recast, it would be the same as entering those figures into the mortgage calculator as if I had a new loan. As I mentioned before, I expect to reduce my payments by about $300/mo, which you can see from the difference in payments below from $1,812
This quick math can come in handy for anyone trying to understand how their advance payments impact how much you save on your mortgage.
Thinking of Renting?
For my personal situation, I’ve always looked at renting my property out after I move out of it as a smart financial move. However, with so much principal paid down in the property, I want to ensure that the property is as high cash flowing (rent – expenses including mortgage) as possible when it is rented out. Recasting opens up that door for me. I’ve got a very low rate (3.675%) that I landed in 2016, though rates have been at record lows in 2020, and at this time refinancing wouldn’t make sense for my situation. Recasting, on the other hand, would put $300/mo less liability on me to pay for if the property is vacant. While $300 may not sound like a lot, the ability to get even more juice out of the property in the short term has long-term compounding benefits as a real estate investor. My reinvestment of this money will be going straight into a house hack to make even more returns.
To save on your mortgage when you’re in a pinch, or want extra cash for any other reason, recasting makes a lot of sense.
Does the process give some money back to the bank long term through interest payments? Yes, yes it does. But, does it lower your monthly costs and risk of having your property taken from you even if you’ve paid down 90% of your loan? Yes.