Finding ways to stretch your budget and decrease monthly expenses is a lifelong struggle. When interest rates were falling, homeowners refinanced — sometime multiple times. Many homeowners now have lower interest rates than what is currently available, so refinancing will not be as financially beneficial. So what other options do you have?
First, try paying a little extra each month toward the principal amount. Applying it to the principal is key to reducing the amount of interest you pay. If you are able to make an extra full payment occasionally, make certain the lender knows you want it applied to principal and to not push out your next due date. Remember interest is calculated daily on the principal balance, so the goal is to reduce the principal whenever possible.
For example: a $350,000 loan, at 5% interest over 30 years (360 months) would have a monthly payment of about $1,878 per month ($624 principal and $1,255 in interest on the first payment). Paying an additional $100 per month would pay off the loan in 322 months (3 years) sooner.
Another option is to “recast” the loan. Recasting allows you to take some of your savings, bonuses or other windfalls and apply those funds toward a large principal reduction, then re-amortize the loan at the lower balance. The loan keeps the same terms in interest rate and the number of years left to pay, but re-amortizing using the new balance decreases the monthly payments.
However, be aware that each mortgage company will have different requirements on the minimum amount needed for a principal reduction ($5,000 and up), how often recasting can be done, and whether or not you are charged a fee for recording the new deed. For example, Wells Fargo requires a minimum of $20,000 towards the principal, but there are no additional costs and no limit to the number of times you can recast. The underlying investor also may have limitation. For example, conventional financing including Alaska Housing Finance usually allows recasting, but FHA and VA do not.
There are two major benefits of recasting over refinancing: 1) A homeowner doesn’t have to qualify for the new payment. You don’t have to worry about your credit score, verifying your employment or income reserves. 2) You save several thousand dollars in closing costs over a traditional refinance. Some mortgage companies may charge a small fee to record the new deed indicating the recast balance and reduced monthly payment due each month.
In the example above, without paying extra towards the principal, in eight years (96 months) the mortgage balance would reach about $300,000. By putting $20,000 towards the principal, you would recast your payment to $1,804 per month.
The savings really start to mount if you have been paying the extra $100 per month. At payment 96 your principal balance would be $288,711. If you recast with the $20,000 additional payment towards the principal, the payment would drop to $1,680 monthly. You could still pay the original mortgage amount and pay off the loan even sooner, or you could repeat the recast cycle as often as you want.
Recasting is especially helpful to homeowners who receive a bonus or inheritance; retirees with investment income, but not a job; or a divorcing spouse who will keep the house, but can’t qualify or afford to refinance on one income alone. For homeowners upgrading, or downgrading, to a new home and who can qualify without selling the old home, they can make a lump sum payment and recast when the old property does sell.
Everyone’s financial situation is different. If you have other high-interest rate loans, those may be the ones to pay off first. However, if your goal is to lower your monthly mortgage payment and keep your current interest rate, recasting may work for you by avoiding the hassle (and cost) of re-qualifying for a new loan.