If you’ve received a large tax refund, you might consider putting it toward your mortgage as a lump-sum payment. If your payment is large enough — typically $5,000 or more — you may qualify for a mortgage recast, which can lower your monthly payment. Or, you could just make a large additional payment against your loan principal without recasting, and continue with the same monthly payment.
Choosing whether to recast depends on how large of a payment you can make and whether you want a lower monthly payment or an accelerated mortgage payoff. Let’s explore the scenarios of making a large payment with and without a recast.
Understanding Mortgage Recasting
“With a recast, a homeowner will typically make a large, lump-sum payment toward the principal and the loan servicer will recalculate the remaining mortgage payments based on how many months are left on your contract,” says Rose Krieger, home loan specialist with Churchill Mortgage. “This means your new monthly payment will be lower.”
Krieger says income change is a common reason to recast a mortgage. For example, retiring and adjusting to living on a fixed income. You keep the original loan term, but the balance is reamortized into a lower monthly payment.
A mortgage recast doesn’t require a credit check, closing costs or a lengthy application process like a refinance does. The duration of your loan and interest rate will not change, but your payment will be lower. Some lenders have a minimum lump-sum payment amount required to request a recast and may charge a recast fee — but it should be less than you’d pay in closing costs on a refinance.
Recasting your mortgage can be a good strategy if you’re nearing retirement or need to reduce monthly payments for cash flow. It’s also more advantageous than refinancing if mortgage rates have increased. You can keep your lower rate and still pay less each month.
Understanding Extra Principal Payments
Making a large extra principal payment will reduce your balance. If you continue making your regular monthly payments after the extra principal payment, you’ll pay off your mortgage faster and reduce the total interest paid.
Though you’ll save on interest, there’s no change to your regular monthly payment unless you request a mortgage recast. “Extra payments will chip away at the amount owed, but unlike a mortgage recast, the required payment on the mortgage will remain the same,” says Kevin Leibowitz, mortgage broker with Grayton Mortgage.
Recasting vs. Extra Payments
Deciding whether or not to recast after making a large principal payment comes down to whether you’re looking to pay off your loan sooner or free up space in your monthly budget.
“The difference between a recast and making extra payments is really about the contracted term length and required monthly payment amount,” says Krieger.
Essentially, you’ll keep your foot on the gas if you maintain your original monthly payment after making a lump-sum principal payment. This accelerates your loan payoff and could shave years off your mortgage while maximizing interest savings. You could still save on interest if you do a recast, and you’ll lower your monthly payment, but your payoff date won’t change.
Let’s compare the payment and interest savings on recasting vs. not recasting. Let’s say you have a $300,000 mortgage originated in 2020 with 25 years left on the term, and you want to make an extra $10,000 payment.
If you make a one-time lump-sum payment without recasting, you’ll pay off your mortgage two years and three months early, while saving more than $42,000 in interest. Recasting your mortgage with a lump-sum payment offers about $11,000 in interest savings and lowers your payment by about $71 per month, but doesn’t accelerate your payoff date.
“Recasts are advantageous when a borrower is interested in reducing the amount that they’re required to pay on a month-to-month basis,” says Leibowitz.
For example, he worked with a borrower who retired and owned a primary and second home. He sold the primary home and used the proceeds to recast his second home and reduce his monthly payment while maintaining an interest rate that’s lower than current market rates.
Alternatives to Recasting and Extra Principal Payments
Chipping away at your mortgage is just one option for a tax windfall. You could also consider keeping cash in a high-yield savings account for emergencies, or investing in stocks, bonds or retirement accounts to potentially grow your money over time. If you have high-interest debt, using a tax windfall to pay it down or eliminate it entirely can offer guaranteed savings on interest.
“When making a large payment and obtaining a recast or just making additional payments on a mortgage, a homeowner is putting more into the equity of their house, which isn’t liquid,” says Leibowitz. “Having cash on hand or in investments can be a better alternative than the additional equity that the homeowner is building.”
How to Decide
“One can make a case for both scenarios,” says Leibowitz. “Reducing debt and paying less in interest is always a good strategy.”
Choose a Recast if:
— You want a lower monthly payment.
— You plan to stay in the home long term and want liquidity.
Make an Extra Principal Payment Without Recasting if:
— You want to pay off your loan faster and reduce your overall interest paid.
— You have stable income and don’t need lower monthly payments.
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I Got a Tax Windfall: Should I Recast My Mortgage or Make a Principal Payment? originally appeared on usnews.com
