Cut Loan Payments With a Mortgage Recast

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If your fixed-rate mortgage payment is too high, there are a couple things you can do: You can refinance to reduce your interest rate, and you might even consider a "cash-in" refinancing, using spare cash to reduce the loan balance, cutting your monthly payment even more.

But what if your rate is already low, and you don’t want to drop more cash on a new appraisal and title insurance?

In that case, there’s an often-overlooked third alternative: a mortgage "recast" or "re-amortization." Lenders aren’t required to do this, but it’s worth asking.

In a recast, the borrower makes a substantial payment to reduce the loan balance. The lender then recalculates the monthly payment based on the lower balance, using the same interest rate and time remaining under the original mortgage terms. Because the borrower still has that loan, there is no costly appraisal or title search.

The process is slightly different from simply making a lump-sum pre-payment on the original loan. When that is done with a fixed-rate mortgage, payments remain the same. The borrower benefits by paying the loan off earlier, saving interest charges in the long run.

Imagine you had taken out a 30-year fixed-rate mortgage five years ago for $300,000, at 6%, the going rate back then. Your monthly payment would be just shy of $1,800, according to the Mortgage Loan Calculator.

After five years, your loan balance would be $279,163. If you paid that down to $200,000 and then had the lender recast the loan, your payments for the next 25 years would be just short of $1,300, a $500-per-month reduction.

Of course, in this case, it might pay to use some of that cash to refinance, as new 30-year loans are averaging around 4.44%, according to the BankingMyWay survey. That way you’d save two ways, cutting the loan balance and the interest rate.

What if you have an adjustable-rate mortgage? In that case recasting is unnecessary. Just make a big principal prepayment before the next annual reset date. With an ARM, a recalculation is automatically done on every reset using the current balance, new interest rate and remaining term. A prepayment will automatically reduce your monthly payment.

Recasting, like any extra principal payment, can be viewed as an investment with a yield equal to the mortgage rate. While you might well earn a bigger return in stocks over time, there would be a good deal of risk. The return from a mortgage prepayment is guaranteed, and earning 4.5% to 6%, or more, looks pretty good next to other safe fixed-income investments. The average five-year certificate of deposit, for instance, yields just 1.7%, according to the survey.

Keep in mind, though, that extra money put into the mortgage is tied up until you sell or take out another mortgage or home-equity loan. Bank savings are much more accessible.

Remember, too, that part of your monthly mortgage payment is for the escrow account to pay real estate taxes and the homeowner’s insurance premium. A principal prepayment won’t change those charges.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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