How does the mortgage recast work?

Definition of mortgage recast

Mortgage recast is when the borrower prepays part or all of the outstanding principal resulting in a reduction of the loan balance and therefore the financial institution recalculates the monthly mortgage loan payments based on the period balance, the amount of principal outstanding, and the interest rate.

• When the borrower has a large amount of money, that money can be transferred to the lender in the form of a mortgage to reduce the outstanding balance of the loan and reduce the interest charge and the monthly principal charge of said loan. .
• Thus, the borrower pays an advance to offset the outstanding principal amount, and the lender recalculates the outstanding amount with the remaining maturity and interest rate, providing the restructured mortgage amount.
• Also, the total amount of interest payable by the borrower to the lender after the mortgage recast will obviously be less compared to the amount the borrower would have paid without doing so.
• This is due to the time value of the money factor present in the calculation of interest on the outstanding principal.

How does the mortgage recast work?

Mortgage recast is based on the basic principle of finance. There are several factors for which the lender charges interest, including both the time factor and the risk factor. The concept of the value of money in time works, taking into account the different elements such as the interest rate, the period of time and the outstanding amount of indebtedness, etc. There are usually specific amortization schedules for repayment of the loan, which include the payment or equal monthly payment of principal and interest according to the predefined rate.

However, if the repayment of the principal is greater than the outstanding balance to be paid in a given installment, the outstanding balance will be recalculated using financial concepts, taking into account the present value of the loan balance discounted at the interest rate.

Mortgage recast calculations

All borrowers do not allow the recasting of a loan. Therefore, the first thing to ensure is that the borrower allows the same according to the contract concluded. The following additional conditions must be met:

1. Minimum principal reduction standards must be met: When the borrower allows recast, there are specific rules related to repayment of the minimum principal amount, which must be met as the first condition.
2. The borrower must pay the recasting fees according to the rules of the financial institutions.

Below is the sample calculation to recast your mortgage.

Detailed report Quantity

Current principal balance $1,125,000.00

Annual interest rate 5.00%

Current monthly principal and interest payments $100,000.00

Remaining Interest Portion $29,671.58

Lump Sum Principal Reduction $500,000.00

recast fee $25,000.00

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

Solution:

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

• Recast Loan Balance = Current Principal Balance – Lump Sum Principal Reduction
• = $1,125,000 – $500,000
• = $625,000

Calculation of the remaining amount of the installment:

• Fee = Principal Amount / Annuity Factor @ 5% for 12 months
• = $625,000 / 11.68122
• = $53,504.69

Types of mortgages that can be repaid

• As mentioned above, only those mortgages in which the specific conditions allow the recast can be recast. These mortgages are associated with a negatively amortized loan, which has a payment structure such that it allows the payment of an amount less than the interest charges of the loan to be scheduled.
• Negatively amortized mortgages are also called payment option adjustable rate mortgages or option ARMs.
• Also, no government-backed loan can be reissued and therefore Jumbo CDs, USDA, VA loan, etc. they cannot be reissued.

Difference Between Recast and Mortgage Refinance

• When the borrower makes a considerable amount of lump sum loan repayment and meets pre-defined conditions, such repayment can be referred to as mortgage recast, while on the other hand, loan refinancing occurs when the borrower converts the loan existing in a new loan that the different terms of the loan are favorable conditions for the borrower. Therefore, there is a fine line that defines the difference between mortgage recast and refinance.
• Under the terms of the former, the borrower makes lump-sum payments in advance of the established payment schedule, and the lender reschedules the amount of the outstanding principal balance whichever is less in terms of annual interest payment, number of years of repayment, and annual repayment in principle, while in the latter, the transfer of the loan takes place when the new lender has transferred the loan from the old lender and further repayment is to be made to the new lender only according to the new terms of the loan. You can also share these with your hiring managers, mortgage recruiters, or relevant acquisition team of your industry to make a list of these five factors.

Pros and cons of mortgage reform

Below are some of the pros and cons of mortgage recasts.

Advantages of mortgage consolidation

1. The total interest paid on the loans is much less compared to the amount of interest payable if the mortgage is not recast. Therefore, it reduces the monthly payment burden
2. The average interest rate payable by the borrower is adjusted to the expected interest rate payable.
3. Requalifying for a new loan becomes tedious work, and therefore the mortgage recast process eliminates the administrative work required to obtain a new loan.

Cons of mortgage recast

1. The mortgage recast process does not reduce the time period of the loan term; therefore, unlike refinancing, it does not reduce the term of the loan.
2. Although the interest payments are reduced due to recasting, the drawback is that it causes more of your money to accumulate in the mortgage and therefore there are chances of a liquidity crisis.
3. Recasting involves charges like fees, administrative charges, etc. and thus increases the burden of financing fees.

conclusion

The above discussion clearly showed that a mortgage recast is different from a refinance due to the aforementioned reasons. In addition, mortgage recasts have provided an easy way for borrowers to reduce the interest burden over a period of time by maintaining the same maturity period and reducing principal repayment each month after providing a lump-sum amount of principal payment for advanced. to the lender.