Mortgage Recast

Mortgage Recast Definition

Mortgage Recast is when the borrower prepays either some or the full amount of outstanding principal resulting in a reduced loan balance, and therefore the financial institution recalculates the mortgage monthly loan payments based on the remaining period, outstanding principal amount, and the rate of interest.

Mortgage Recast

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Source: Mortgage Recast (wallstreetmojo.com)

How does Mortgage Recasting Works?

The mortgage recasting works on the basic principle of finance.  There are several factors because of which interest is charged by the lender, which includes time factor as well as a risk factor. The concept of the time value of moneyConcept Of The Time Value Of MoneyThe Time Value of Money (TVM) principle states that money received in the present is of higher worth than money received in the future because money received now can be invested and used to generate cash flows to the enterprise in the future in the form of interest or from future investment appreciation and reinvestment.read more work, taking into consideration the different elements such as rate of interest, time period, and outstanding amount of borrowing, etc. Normally there are specific amortization schedules for loan repayment, which includes equal monthly payment or payment of principal and interest as per predefined rate.

However, if the principal repayment is higher than the outstanding amount payable on a specific installment, the balance amount outstanding shall be recalculated using the finance concepts taking into account the present valuePresent ValuePresent Value (PV) is the today's value of money you expect to get from future income. It is computed as the sum of future investment returns discounted at a certain rate of return expectation.read more of the balance loan amount discounted at the rate of interest.

Mortgage Recast Calculations

Every borrower does not allow a loan recasting. Thus the first thing to be assured is that the borrower allows the same as per the contract entered. Further following conditions must be satisfied:

  1. The minimum principal reduction standards must be fulfilled: where the borrower allows recasting, there are specific norms related to minimum amount repayment of principal, which needs to be satisfied as a first condition.
  2. Recasting fees are to be paid by the borrower as per the norms of financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more.

Given below is the calculation example to recast your mortgage.

ParticularsAmount
Current Principal Balance$1,125,000.00
Annual Interest Rate5.00%
Current Monthly Principal and Interest Payments$100,000.00
Interest portion left$29,671.58
Lump-Sum reduction in principal$500,000.00
Recasting Fee$25,000.00

The number of remaining payments is 12. Calculate the recast mortgage savings.

Solution:

The number of remaining payments is 12. Now, we will calculate the recast loan balance first.

Recast Loan Balance
  • Recast loan balance = Current principal balance – Lump-sum reduction in principal
  • = $1,125,000 – $500,000
  • = $625,000

Calculation of the remaining installment amount:

  • Installment = Principal amount / Annuity factor @5% for 12 months
  • = $625,000 / 11.68122
  • = $53,504.69
Recast ComparisonPaymentInterest
Existing Terms:$100,000.00$29,671.58
Recast Terms:$53,504.69$42,056.11
Recast Savings:$46,495.31-$12,384.53
Payment Reschedule

Types of Mortgages that may be Recasted

  • As mentioned earlier, only those mortgages in which the specific conditions are allowing the recasting is there can only be recast. Such mortgages are associated with a negatively amortized loan, which has a payment structure such that allows schedule repayment of an amount less than the loan’s interest charges.
  • Negatively amortized mortgages are also termed as payment option adjustable-rate mortgages or Option ARM.
  • Further, no government-backed loan can be re-casted, and hence, Jumbo CDs, USDA, VA loan, etc. cannot be recast.

Difference between Mortgage Recasting and Refinancing

  • Where the borrower makes a sizable amount of lump-sum loan repayment and fulfills the predefined conditions, then such repayment can be termed as mortgage recasting while, on the other hand, loan refinancing happens when the borrower turns the existing loan into a new loan which different terms of the loan being favorable terms for the borrower. Thus there is a thin line that defines the difference between mortgage recasting and refinancing.
  • Under the terms of the former, the borrower makes lump-sum payments making himself or herself ahead from the stated schedule of repayment, and the lender rescheduled the principal balance amount outstanding being the amount lower in terms of annual interest payment, number of years of repayment, and annual repayment of principle, while in the later, transfer of loan takes place where the new lender has been transferred the loan from the old lender and the further repayment is to be done to the new lender only as per the new terms of the loan.

Mortgage Recast Pros and Cons

Given below are some of the pros and cons of mortgage recasting.

Mortgage Recasting Pros

  1. The overall interest paid on the borrowings is much lower as compared to what amount of interest payable if the recasting of mortgage is not done. Hence, it lowers the monthly payment Burden
  2. The average interest rate payable by the borrower gets in line with the expected rate of interest payable.
  3. Re-qualifying for a new loan becomes a tedious job, and hence the process of mortgage recasting removes the administrative works of obtaining a new loan.

Mortgage Recasting Cons

  1. The process of mortgage recasting doesn’t shortage the time period the term of the loan; hence unlike refinancing, it doesn’t reduce the loan period.
  2. Though the interest payments get reduced due to recasting, the drawback is that it makes more of your money get types up in the mortgage, and hence there are chances of liquidity crunch.
  3. Recasting involves charges like fees, administrative charges, etc., and hence the financing fees burden increases.

Conclusion

The above discussion clearly showed that a mortgage recasting is different from refinancingRefinancingRefinancing is defined as taking a new debt obligation in exchange for an ongoing debt obligation. In other words, it is merely an act of replacing an ongoing debt obligation with a further debt obligation concerning specific terms and conditions like interest rates tenure.read more due to the above-mentioned reasons. Also, mortgage recasting has provided an easy way for the borrowers in order to reduce the interest burden over a period of time by keeping the maturity period the same and to lower the principal repayment every month after providing a lump sum amount of principal payment in advance to the lender.

This has been a guide to Mortgage Recast and its definition. Here we discuss how to calculate mortgage recast along with examples, types, pros, and cons. You can learn more from the following articles –

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