Recasting/Re-amortization of Mortgage with Principal Prepayment

I’m getting ready to pay some extra money towards my mortgage loan, and remembered that I have an option to re-amortize my mortgage loan if I make a substantial principal prepayment. This is also known as “recasting” a mortgage. Basically, my monthly payments are lowered slightly over the same remaining term instead of simply accelerating my loan payoff schedule. My interest rate and escrow payments stay the same, and I don’t have to pay any fees or closing costs.

Most loans that are sold off to investors do not allow recasting, as I imagine they don’t want the added complexity. However, some allow either a one-time recast, and other allow repeated recasting if the extra payment is large enough. Ask your lender about this feature beforehand if you’re interested in it. In my case, I get to re-amortize whenever I pay a lump-sum of at least $10,000.

My tentative plan, discussed briefly in my Quick & Dirty Plan To Reach Financial Freedom, is to make two extra mortgage payments a year. (If interest rates rise enough, the money will simply be placed into a long-term bond.) This will shorten my 30-year mortgage by an entire decade, so I’m mortgage-free in 20 years at age 50. The commonly discussed biweekly payment plan is the same as making one extra mortgage payment each year, and knocking off about 5-6 years.

For my mortgage, if I pay exactly $10,000, it would only lower my normal mortgage payment about $50 a month. Theoretically, if I keep my payments the same as if I didn’t re-amortize, my total interest paid would be the same, and my loan would still be paid off 10 years early. The lower required mortgage payment would simply provide an added bit of flexibility in case I run into financial trouble.

However, for my situation the $10,000 requirement would mean I’d have to wait and lump my payments every other year instead of making the payments whenever I like. I don’t think $50 a month is worth the added hassle, as I really do want to have this thing paid off in 20 years.

(As a reminder, I think paying extra towards your mortgage should only be done after you have maxed out your tax-deferred accounts like IRAs/401ks, as well maintaining an emergency fund or other liquid assets.)

Comments

  1. I think it is a great idea to pay off your mortgage early.Tthe sense off security you will feel from owning your place free and clear is very nice.Also for some people it is a great way to invest rather then spend their money.In theory while it may make sense to pay the mininmum on your mortgage and invest the rest it takes a displined investor to do that.

  2. Do you know that eventually you will not be able to deduct mortgage interest and would want to pay off mortgage in lump sum? Paying off mortgage early may be a good idea depending on rate. Just something to consider.

  3. @fortune:

    Removing the mortgage interest deduct will be one of the biggest political blunders in history. Although, with our current President and Congress, nothing is off the table to pay for their government programs since individuals can’t take care of themselves.

    Jonathan, thanks for the post on recasting! I did not know the some lenders allowed reamortization on a loans and it will be very helpful with rental properties to sqeeze a little more cash flow per month.

  4. @Albert

    I am not saying that government might be removing mortgage interest deduction.

    First of all, I am a tax advisor and was in the camp of making extra monthly payment to principal regularly. I have a few clients that have mortgage balances where they have 7k mortgage interest and are not able to itemized deduction.

    Had 3 clients who had over 100k in liquid asset. Advise clients to pay off mortgage in lump sum if discipline to make mortgage payment back to self. To my surprise the did it the next day.

    There are always 2 sides to a coin and I am just trying to present the other side. There is no right and wrong. Ultimately one does what one is most comfortable with.

  5. I get paid biweekly and here is my plan

    1.) monthly payment divided by 12 = 1/12 monthly payment

    2.) monthly payment plus 1/12 monthly payment = new monthly payment

    3.) new monthly payment divided by 2 = 1/2 of new monthly payment

    4.) every other paycheck take 1/2 of the new monthly payment out and sit aside

    5.) every other paycheck pay in full of new monthly payment towards mortgage

    If you pay 12 payments a year that ends up paying ’13 payments’ in total while actually only making 12. But if you base it off biweekly paychecks, you’ll actually pay 13 payments a year which makes it 14 payments in total while only making 13. If you do the math, it is cheaper in compounded interest to pay 1/12 extra a month more than to pay a 13th payment at the end or first of the year.

    Around June or July you’ll start to realize you’ve paid around 2 months ahead of your mortgage. Personally, I love that feeling.

    I’ve went over the idea of placing extra payments into investments if the interest rate is higher than the loan interest rate. The math doesn’t work out for me but I may be wrong.

    Example:

    1.) $150,000 mortgage @ 5.33% for 30 years with a monthly payment of $835.75

    2.) 5.33% is 100% interest as percentage of the principal. Which means you could have bought 2 homes after 30 years of savings $835.75 a month. Which is a total of $300,870.

    3.) Pay $1600 a month and have it paid off in 10 years.

    4.) That is $764.25 extra a month and $9,171 extra year.

    5.) Lets say, 3 year CD @ 8%. 8% – 5.33% = 2.67% profit

    6.) $9,171 @ 2.67% = $244.87

    7.) If you did a 3 year CD @ 8% every year until the 10th year you would only gain $244.87 for the one year starting at the 3rd year.

    8.) 1st to the 7th year to end up paying it off at 10 years. But that would leave 3 years of $9,171 going where? Because if it was each year, the the $9,171 CD at the 10th year wouldn’t mature until the 13th year.

    9.) 10 years of CD investing X $244.78 = $2,447.80 profit for going with CDs to pay your mortgage off in 13 years instead of 10. Which isn’t profit because you’ll paid more interest from the additional 3 years.

    Even with a one year CD you would still expand it to 11 years. Why not just pay as much as possible towards the mortgage so you’re not obligated at a specific age in your lifetime to pay a mortgage. I rather not be 46 still paying a mortgage unless it is the absolute dream home and my death bed (live there for the rest of my life).

    I’m sure I missed a point in the math and hopefully someone will point it out.

  6. Does recasting the mortgage cost you anything to do it?

  7. Jim,

    The answer is in the 1st paragraph:

    “My interest rate and escrow payments stay the same, and I don’t have to pay any fees or closing costs.”

  8. I’m a little curious why you’d rather pay down your mortgage early than put the same amount towards a possible rental/investment property — given the current market. But, of course, maybe you can afford to do both!

  9. Recasting seems to only be beneficial if your concern is cash flow. Albert’s example seem to be where this would make the most sense to me, using it to squeeze more cash flow from a rental property. If your plan is as you stated (to pay the house off early) then recasting shouldn’t even be near the table let alone on it.

    Also, as it pertains to the mortgage interest deduction. I personally don’t let that dictate how much extra principal I pay. Tax deductions are fine but opting to pay MORE in interest to get a few dollars back in the form of less taxes is financially brain dead to me. People get too caught up in the deduction instead of focusing on the amount of money they are actually GIVING AWAY to keep the deduction. Maybe if it brings you to a lower tax bracket you should consider it, but you can accomplish the same thing by giving money away in the form of charity instead of interest payments. That way you pay less in taxes and at the same time you get a warm fuzzy feeling for having done some good in the world.

  10. Thanks Robert. Sorry I read right over that. My bad.

  11. Milhouse says:

    @Robert – From my perspective the deduction is important as it changes the math. If you’re paying 6% on your mortgage, and get 25% of your interest payments back in the form of a tax break, then your effective interest rate is roughly 4.5%. I feel confident enough that I can get more than a 4.5% return on my money somewhere. Generally not the case over the last 10 months, but we’ve seen an unusual situation during that time

    Part of my thought process here also revolves around diversification – with high levels of equity in my home I then tilt my asset allocation heavily to real estate. I don’t want to overallocate there, shorting my exposure to stocks, bonds and cash instruments.

    I think the latter issue is overlooked too often.

  12. I have not seen anything that would cashflow positive in my neck of the woods that would not require a ton of maintenance or a huge downpayment. I’m just waiting it out.

  13. Milhouse,

    I used to make that exact argument, but when I actually started doing my taxes, the math didn’t work out. The thing you have to keep in mind, is that you ONLY benefit from interest you pay above and beyond your standard deduction. I’m married, so my standard deduction is $11,400.

    In other words, if I pay $11,000 in mortgage interest this year, I would be better off NOT claiming any of that as a deduction and taking the standard deduction.

    To put that in real terms, If I had a $183K loan outstanding and was paying 6% interest (the aforementioned $11,000) I would see no tax break from the government. I would still be effectively paying 6%, not 4.5%.

  14. Jonathan,

    Question for you… Even on the shortened payoff schedule for your home (20 years instead of 30) every early payment is effectively earning you 5.125% on that payment. (Maybe a bit less as you probably get some tax benefit… so let’s say 4.75%) A much better return than a CD or Money Market at the moment, but then again, you no longer have access to that money without selling your home.

    The question is, do you think if you put that money into the stock market with a 20 year investment horizon you would earn more than 4.75% on it?

    While there are rare occasions when stocks have underperformed 5% over 20 years, I would guess none of those stretches started after a major correction in the market.

  15. Reading this post makes me wonder- do bi-weekly payments have the same advantages for student loans?

  16. Dee,

    As long as it’s not one of those bi-weekly payment plans that you pay for. I get sick of those offers that come in the mail asking me to pay some fee to make the equivalent of 1 extra payment a year.

    Before Washington Mutual (now Chase) got rid of the payment option to pay every 4 weeks, I paid my mortgage every 4 weeks automatically which works out to 1 extra payment a year (52/4 = 13). Paying extra on any loan can’t hurt your really but you just have to decide if that’s where you want your extra money to go.

  17. @ Dee: I have student loans through wells Fargo, and used to pay quite a bit more than what was owed every month. After about 6 months of doing that, I noticed my payments got a bit smaller. I called to ask about it and was told my loan was re-amortized due to my extra payments. They didn’t call it “recasting” but it sounds like the same thing. Good for cash flow indeed. Stopped paying extra though since the interest rate is so low, it really makes no sense to pay aggresively on it.

  18. @Maury – Yes, I treat paying off the mortgage as similar to buying a long-term bond paying my mortgage interest rate of 5.125%. Right now, that’s higher than a Treasury. But later on, it might be lower, so I’ll just buy bonds instead at that time.

    I don’t choose to compare it to stocks, because stocks have a different risk/reward ratio. Could the return be greater? I certainly hope so. But that doesn’t mean I’m going to be 100% stocks either.

  19. I never compare to stocks. Lost so much last year it’s not funny.

    I always pay 2-5 extra principal payments on my rental property a year, which costs 5.25%.

    My primary residence is at 4.65% and I have a tax deduction.

    Rgds,

    RB

  20. I knocked over 10% off of my 5.625% mortgage back in January by doing this. I plan on selling the place in a couple of years, and I feel like my cash is “earning” more for me this way than in some CD of MMA. Also, based on my situation, I will no longer be able to itemize as of 2009 so I will get no mortgage interest deduction. I chose not to recast because my mortgage payment is easy so why reduce it. Thus I am also getting higher principal contributions. Paying down the mortgage in a lump sum carries a ton more weight in the early years than the later years merely based on the amount of time from which you get the benefit.

    I would put another chunk down on my mortgage again at this point, but I also do not want all my money tied up in a place that I may not be able to sell in 2 years (stupid economy). Unfortunately, I have to hedge my bets.

  21. JeeddddCamplet says:

    In California if your home is foreclosed and if your liability exceeds the value of your home, the remain amount gets wiped away.

  22. The California obsession with housing continues. You are putting 10k towards a depreciating asset. Your home’s value will still continue to fall because of less immigration to the state and there is no more leapfrogging the middle class homebuyers with junk loans to the unqualified. Living here in the midwest it was comical listening to all the chatter about housing housing–nobody still talks about housing out here–yes the value here is less far less but maybe just maybe I will be able to afford tuition at a college now that homeowners on the coasts can’t take out fake equity to send junior to college thereby pushing the costs up on the rest of us.

  23. @JeeddddCamplet

    That is absolutely not true. You can surrender the deed only on first cash purchase. Once you refinance, then it’s over. However, currently the government is allowing mortgage debt forgiveness up to 2010.

  24. Another invaluable piece of financial advice from Jonathan. I had never heard of the option of recasting/re-amortizing mortages without doing a refi. Wish you had published this before I got my current mortgage.

    Any estimates on how much having the recasting option would cost in interest rate? (And don’t say none. No such thing as a free lunch. I’m talking about comparing the best rate you could get on a 30 year fixed with recasting vs 30 year fixed without recasting.) If it’s only .25 or .5 difference, that is worth the flexibility later on.

  25. Hi Jonathan,

    Do you mind sharing which mortgage lender you are working with that gives you the option of re-casting/re-amortizing of mortgages? I’ve asked a couple of banks recently, and most do not have a clue on what I’m talking about. Thanks!

  26. I have a 30 yr fixed loan @ 4.95% fixed. My lending institution is Third Fed. I am able to re-cast anytime that I have $5000.00 This will lower my monthly payment and costs nothing.

  27. I have just sent in my payment to do a recast. My wife and I are in diaagreement. What happens to the amount of my mortgage payment that goes to the principle. Does is increase, stay the same or decrease.

  28. If you send in a large principal paydown, but do not recast, your monthly payment will stay the same, but you will pay less in interest and more in principal. Your interest payments will drop faster and you will pay off sooner.

    If you pay down and recast, your monthly payment will be smaller. You will pay the same interest as without recasting initially, but you will pay less in principal because it will be spread over the original term of the loan.

  29. lon cinglar says:

    There are fewer things I want than sinking a penny extra in a item that it not liquid.

    tax break good , tax break bad, it does not matter.
    If I got ill tomorrow or my wife had to move back home or my job moved my positions to Maine and I were left holding a house I could not sell, rent or give away those couple of thousand dollars will mean nothing.

    And unfortunately there are probably more areas around the country that are in similar slow sales areas.

    A T-Bill, stock, municipal bonds, gold or silver .. I can sell those tomorrow morning by 10 am.

  30. lon cinglar says:

    The other thing people need to think of – instead of paying extra towards that house could you be taking the same money, pretax of course, and contributing it towards any type of retirement plan ?

    While your interest deductions will drop over time on a mortgage the growth of pre-tax dollars will always have the extra leverage of the invested money being not yet subject to taxes.

  31. Assuming you have invested in other areas (businesses, stocks, retirement) and you have emergency funds on hand, it seems that your home in the right market is also a solid retirement investment. Those who argue against it make a poor argument to me unless they live in an undesirable location.

    Housing starts have been down for a while I thought – and the U.S. population continues to increase. Existing homes at least in desirable areas are continuing to appreciate. Inflation will happen (as it has been) and though we may not see the “real” number we all know how much more it costs to eat, hire contractors to build things, etc. Building a new home in ten years may be considerably more than it is now.

    Investing in stocks and bonds can be great – or can be a huge downfall. Most investors don’t understand the tax consequences, etc. on these investments making them even more risky.

  32. hiersoul says:

    I just recast my mortgage and made a substantial payment towards the mortgage. They reamortized the loan and everything stayed the same but of course the payment went down. I have an investment property already and so the sooner I pay off this mortgage, primary residence, that would be great. CitiMortgage charges $500 to do so and you can do it once every 12 month period but the amount must be greater than 5k.
    My payment was reduced about $200 a month which I will still pay but straight towards principal. My current payment was high and I never paid extra towards principal but in this way i will. The amount that goes towards principal without making an added contribution was only about $65 less and so it was a no brainer to me to do the recast and then pay a few hunded each month towards the principal and be where i am at right now with my current amount that I have to pay. I hope I am making sense as I am writing this quickly before I leave out. Anyway, it works for me. The investment property pays for itself as it is a summer beach rental and the summer rentals pays the mortgage for the year so I think I am all good. It was worth the $500 to me to pay a big chunk down and now send in more each more towards the principal since the payment is lower. And if I come upon hard times at least the payment is lower…smiles.

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