Recasting a mortgage

In short

A friend of mine paid a big chunk onto his mortgage last spring and wondered why his monthly bill never changed. If you are holding a mortgage and a pile of cash, you may have wondered the same thing. A recast is a small request to your lender. The borrower sends in a lump sum, and the lender rebuilds the payment schedule around the smaller balance. The loan term stays the same, and the interest rate stays the same, but the monthly payment drops. Most lenders charge a modest fee, and many set a minimum for the lump sum, so ask your servicer for its written terms. It is not a refinance. There is no new loan, no new rate, and no new closing costs.

The whole of it

What it is

I once watched a neighbor spend an entire Saturday trying to explain to his bank why he did not want a whole new loan. He only wanted his bill to shrink. That is the gap a recast fills.

A recast, which some lenders call a reamortization, is a change to the payment schedule of the loan you already have. The borrower pays a large amount toward the principal, which is the money actually borrowed. The lender then runs the math again. The same rate and the same end date now apply to a smaller balance. So the monthly payment falls.

Keep one thing straight. Paying extra on a mortgage does not lower the bill by itself. An extra payment shortens the life of the loan, because the balance drops faster. The bill stays where it was until the lender recasts. Only the recast resets the payment.

Not every loan can be recast. Conventional loans often allow it, since the lender holds the right to decide. Loans backed by the Federal Housing Administration, the Department of Veterans Affairs, and the Department of Agriculture generally are not eligible, according to the lenders and servicers who publish their recast rules. Your own note and your servicer's policy settle the question. Nobody else can.

How it works

If you have ever watched a bank teller count a stack of bills twice, you know the care that goes into a lump sum. A recast takes the same care, and it follows a short path.

First, the borrower asks the servicer, which is the company that collects the monthly payment, whether the loan can be recast. Second, the servicer states its minimum lump sum, its fee, and any rule about timing. Some servicers require that the borrower stay current on all payments. Third, the borrower sends the lump sum toward principal. Fourth, the servicer reworks the schedule and sends a new payment amount, usually starting with a later billing cycle.

The interest rate does not move. The end date does not move. If your loan was a 30 year loan with 25 years left, it is still a loan with 25 years left. The only thing that changes is how much each month has to cover.

Here is the part that surprises folks. The lump sum is not a gift to the lender. It lowers the balance, and interest is charged on the balance. So a smaller balance means less interest from that day forward, even before the new payment kicks in.

The numbers, and where to find yours

Your own papers hold the numbers that matter, and you can find them without any special skill.

Look at your latest mortgage statement for the current principal balance, the interest rate, and the monthly payment. Look at your original note for the rate and the term. Then ask your servicer, in writing, for three things: the minimum lump sum it will accept for a recast, the recast fee, and the date the new payment would start. Fees vary by lender, so the figure on your own servicer's page is the one that counts.

If you want to understand how the loan itself is built, the Consumer Financial Protection Bureau publishes plain guides on mortgage payments and on how escrow works. Escrow is the account where your servicer holds money for property taxes and insurance. A recast changes the principal and interest part of your payment. It does not change the escrow part, so your taxes and insurance still ride along on top.

A worked example

I want to tell you about a woman I will call Maria, because her story shows the whole thing better than a table could.

Maria owes $300,000 on a mortgage at 6 percent, with 25 years left. Her principal and interest payment is $1,933 a month. She then sells an old rental property and clears $100,000 after tax. She asks her servicer to recast, and the servicer agrees for a $250 fee.

Her new balance is $300,000 minus $100,000, which is $200,000. The rate is still 6 percent a year, so the monthly rate is 0.5 percent, or 0.005. The term is still 25 years, which is 300 months.

The standard payment formula is the balance times the monthly rate, divided by one minus the quantity one plus the monthly rate raised to the negative number of months. With her figures, that is $200,000 times 0.005, divided by one minus 1.005 to the power of negative 300. The top is $1,000. The bottom is 1 minus 0.2233, which is 0.7767. So $1,000 divided by 0.7767 is about $1,288.

Her payment drops from $1,933 to about $1,288. That is a saving of about $645 a month. Over a year, $645 times 12 is $7,740.

Now the quiet truth. Maria did not shorten her loan. She still has 25 years to go. If she had kept the old $1,933 payment after paying down $100,000, the loan would end much sooner and she would pay far less interest in total. With the recast, she gets breathing room each month, and she gives up some of that interest savings. Both choices are honest ones. They answer different wants.

Where it goes wrong

I have seen good people trip over this, and not one of them was foolish. It is an easy thing to misunderstand.

The first trap is mixing up a recast with a refinance. A refinance replaces the loan and can change the rate. A recast does not. If your rate is high and rates have fallen, a recast leaves that high rate in place. The reverse is also true. If your rate is low, a recast keeps it, and a refinance would throw that advantage away.

The second trap is eligibility. The borrower assumes the loan can be recast, sends the money, and finds out later that the servicer does not allow it. Ask first, and get the answer in writing before any money moves.

The third trap is the cash itself. A lump sum sent to the mortgage is no longer sitting in a savings account. It is tied up in the house. A borrower who needs that money later would have to borrow against the home or sell it. Think about an emergency cushion before sending a large sum anywhere.

The fourth trap is the fee and the minimum. A $250 fee is small beside a $100,000 payment. It is large beside a $5,000 one. Many servicers set a minimum lump sum, so a small extra payment may not qualify at all.

The fifth trap is tax. A recast does not change the tax rules by itself, but the mortgage interest deduction depends on your balance and your situation. The Internal Revenue Service explains the rules in Publication 936. A tax professional can speak to your own case.

Questions to answer before you leave this page

Have you asked your servicer, in writing, whether your loan can be recast at all? Do you know the minimum lump sum it wants and the fee it charges? Is your goal a smaller monthly bill, a shorter loan, or the lowest total interest, and do you see that those goals pull in different directions? If you send a large sum to the house, will you still have enough cash set aside for a rough month? Is your current rate one you are glad to keep, or one you would rather replace? And have you looked at your latest statement to see your real balance, your real rate, and your real payment before you decide anything?