Refinance, Recast and Loan Modification
We’ve seen interest rates gradually rise over the past 12 months or so both as a result of credit market forces as well as a direct result of actions taken by the Federal Reserve. Last March the Fed raised rates for the second time in four months by 0.25%, matching the move taken last December. Today, the Federal Funds rate is at 1.00%.
It’s not exactly clear what the Fed intends to do at this stage, earlier this year Fed Chair Janet Yellen commented we could expect a total of three rate increases in 2017, with the March move being the first. Yet that’s not a given and some are thinking perhaps one more increase is in store for 2017 while others are thinking the Fed will stand pat at least until 2018.
As rates move lower, thoughts lean to refinancing. Yet it’s not very likely we’ll see any rate substantial rate decrease for the rest of the year which could lead to another refinance wave. Pundits predict the refinance market is mostly lower, at least as it relates to getting a lower rate. For those who a refinance could be a benefit are those with any sort of balloon mortgage or an adjustable rate or hybrid loan and the owners are thinking long term where fixed rates are in their current range. To get a lower rate or switch from a variable rate to a fixed, a refinance is the traditional method. Yet there are two other ways to adjust the terms of a note- a recast and a loan modification.
In the mortgage industry there is a term called Recasting, sometimes referred to as re-amortizing. In essence a recast is a way to lower a monthly payment by adjusting the term of the loan. With a recast, there is no requirement the rate must be lower or you’re changing from one loan type to another. A recast doesn’t change the rate on the loan.
How does it work?
A recast requires the borrower to make a one-time lump sum payment toward the principal balance, far and above the monthly mortgage payment. Most lenders require the minimum amount paid toward the balance of the loan be at least $5,000 yet most recasts involve principal pay downs in much larger amounts. Borrowers typically start thinking of a recast after receiving a lump sum payment such as from an inheritance, sale of an asset or other financial dividend.
The borrowers contact their lender and talk about a recast using the additional windfall. For example, a couple takes out a 30 year mortgage and 10 years later inherit $30,000. They consider what to do with the funds and after reviewing their options they decide to avoid stocks or mutual funds and instead put the amount toward their mortgage balance. Yet while a lender will allow a $30,000 payment to an outstanding without using a refinance nothing happens to your loan term, it’s the same 30 year fixed with 20 years remaining.
With a recast however, the lender can apply the $30,000 to the principal balance and re-amortize, or recast the loan over the remaining 20 years. Doing so reduces the monthly payment without refinancing because the payments are based upon the lower loan amount. With a 30 year fixed rate mortgage the monthly payments stay the same throughout the term of the loan but when recasting the monthly payments are based upon the newly reduced loan amount. Essentially it’s a refinance without the associated costs and fees involved. Not all lenders will accept a mortgage recast so you’ll need to find out if your lender will allow for one so you’ll need to find out in advance from your lender is a recast is possible. There is also a small fee associated with a recast, typically less than $500. The borrowers do not have to complete a loan application or provide income documentation as with a typical refinance.
A loan modification also changes the terms of the loan yet is typically only available to those who are experiencing financial difficulties. When borrowers begin to fall behind on their mortgage payments the mortgage lender can offer a loan modification. The borrowers can also make a direct request for a loan modification as well.
A loan modification changes the terms of the note by adjusting the interest rate on the mortgage or changing the loan term. With a loan modification there is no principal paydown as required with a recast. With a modification, borrowers are required to document why a loan modification is needed. If borrowers become two or three months behind the lender often sends the borrowers information on a modification.
With a modification the borrowers will be asked to provide income and asset documentation and explain why they’re having difficulty paying back the mortgage. Typically it’s due to the loss of job or for medical reasons. The borrowers provide the necessary documentation and the lender reviews the application. They consider the monthly income and adjust the rate either permanently or temporarily and can also extend the loan term which also lowers the monthly payment. Only the entity that services your mortgage, the company you send your payments to, can modify your mortgage loan.
Of the three options, a mortgage recast is likely the best choice if your lender allows it due to the low costs and relative ease of re-amortizing the loan amount. The two key factors when considering a recast is your current rate versus market rates and how many years are left on your loan.