Mortgage Recast Question

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Topic Author
TCP
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Joined: Fri Jun 07, 2013 1:12 pm

Mortgage Recast Question

Post by TCP »

My DW and I finally sold our condo and will be coming into a significant amount of money from it. She wants to put most of it towards the mortgage on our house. It is a 30 year fixed at 3.625%. It would be a recast, not a refinance. I called Wells Fargo (they originated and still own the mortgage) and had them run the numbers. Putting 100k down would reduce our monthly payment by approximately 460$/month. Multiplied by 12 months gives us saving 5,520$ in mortgage payments per year. Is this a guaranteed return of 5.5% for the length of our mortgage or am I overlooking something? I thought the return would be the mortgage rate, but the math seems to say otherwise? I feel like I'm missing something obvious, but I can't see it.

As always, thanks for your wisdom
orca91
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Re: Mortgage Recast Question

Post by orca91 »

Why do you want to recast? If you don't need to lower the monthly payment, it's not that great a deal IMO. Doing so also restarts the amortization schedule and most of your payments go to interest again.

If you just throw $100k at the current mortgage and stick with that, the monthly interest paid would probably go down significantly. Maybe more that doing the recast? If you can afford the monthly payment, a cash in refinance to a 15 year mortgage with a lower rate could save even more interest.

It depends on what your goals are with the recast.

I'm not sure where you get the 5.5% return from. You're simply not paying 3.625% on the $100k ever again. You can't really get over that somehow...
dcd72
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Re: Mortgage Recast Question

Post by dcd72 »

orca91 wrote:Doing so also restarts the amortization schedule and most of your payments go to interest again.
No, that's a refinance. The entire point of recasting a mortgage is that it DOESN'T restart the amortization schedule.
jfave33
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Re: Mortgage Recast Question

Post by jfave33 »

dcd72 wrote:
orca91 wrote:Doing so also restarts the amortization schedule and most of your payments go to interest again.
No, that's a refinance. The entire point of recasting a mortgage is that it DOESN'T restart the amortization schedule.

Yes but you don't pay off your mortgage any sooner with a recast. If you just paid $100k with no recast you would cut off years off your mortgage.

A recast just helps with cashflow. Say you had a mortgage with 20 years left. With paying the $100k and no recast that would reduce to say 16 years. If you recast you would be back to paying for 20 years but would pay less each month.

You could consider a loan modification. Pay off $100k to lower your balance. Also pay a small fee to modify the mortgage such that the rate is lower and so the monthly payments are lower. That may allow you to lower your rate, payment and term. But probably not since that 30 year rate seems good already.

Probably just best to pay off $100k and leave the recast unless you want the cash flow now. Benefit is the mortgage rate and not 5.5%!
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Watty
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Re: Mortgage Recast Question

Post by Watty »

TCP wrote:It is a 30 year fixed at 3.625%. It would be a recast, not a refinance. I called Wells Fargo (they originated and still own the mortgage) and had them run the numbers. Putting 100k down would reduce our monthly payment by approximately 460$/month. Multiplied by 12 months gives us saving 5,520$ in mortgage payments per year. Is this a guaranteed return of 5.5% for the length of our mortgage or am I overlooking something?
A large part of your mortgage payment is repaying principal and you are including that in your calculations of your savings. For example if your mortgage payment is $1,000 and $200 is repaying principal then $200 of your net worth moves from your checking account into home equity when you make the $1,000 mortgage payment. If you totally paid off that loan then you would only be saving $800 a month

You would save about $3,625 in interest the first year but the amount would change each year as the loan is paid down.

If you are able to itemize your mortgage interest and are in the 20% tax bracket then you would also pay $725 more in taxes because you would have less interest to deduct. That would reduce the overall savings to $2,900

You would also have lost interest on the $100K that you could have left in the bank. If you had put it in a CD that earned you $1,000 after paying taxes on it that would also reduce your overall savings to somewhere around $1,900.

All the numbers would change each year as the mortgage is paid down.

I would take a look at refinancing to a shorter loan at a lower interest rate after paying the loan down by $100K. That might cut years off the mortgage but might leave your mortgage payment about the same or even lower than it is now.
Topic Author
TCP
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Re: Mortgage Recast Question

Post by TCP »

Ahhhh, there it is, thanks Watty. I knew I was missing something simple. Thank you. Yes, it is a recast, not a refinance so length of loan would not change, just lower the monthly payment. Will be in either the 33 or 35% tax bracket so mortgage deduction is one of the few tax breaks I get. We recently moved (sept 2015) due to our increase in family size so the mortgage is also less than a year old. Last month we sold our old house and I dumped the proceeds into the market. The condo is scheduled to close at the end of the month and it was my wife's place before we married so it is "her" money. I would put it in the market but she wants to recast. I don't think that is a terrible decision although now that we are down to 1 mortgage (from 3!) cash flow is not a problem. She said we would be a getting 5.5% return on the money used to recast and it just didn't sound right to me. Now I know my initial hunch was correct and the reasoning behind it. I'm in no rush to pay this off as it is a great inflation hedge, it is not a drag on our monthly cash flow, we put a large amount down, and we plan to live there for the next 15-20 years. With the deduction my effective mortgage rate is around 2.4%. With such a low effective rate is refinancing to a 15 year worth it? Or should I just dump more money into the market and hope for greater than 2.4% returns over my 20-25 year horizon, which seems likely?
icefr
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Re: Mortgage Recast Question

Post by icefr »

I would say that if it is "her" money and she wants to put it into the mortgage, I would do that, especially if you dumped the proceeds of your old house into the market and she wants to put this one into the mortgage. Compromise is important in a relationship :)

But recasting isn't necessarily the right way. As others have said, all it really does is improve cash flow. If you're fine with your cash flow status with the current mortgage payment, you could just make a principal payment and then the mortgage will be paid off sooner (amortization will be reduced).

How big is the mortgage balance now? i.e. would $100k make it under $100k? At that point, you can't really refinance anymore, so I would just make a large extra principal payment and enjoy the reduced amortization. If the $100k would mean that you're essentially on a 15 or 20 year amortization now, you could investigate if you could lower the rate even further by refinancing into a mortgage with a shorter amortization, so long as the closing costs would make the breakeven point reasonable.
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Watty
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Re: Mortgage Recast Question

Post by Watty »

TCP wrote:With the deduction my effective mortgage rate is around 2.4%. With such a low effective rate is refinancing to a 15 year worth it? Or should I just dump more money into the market and hope for greater than 2.4% returns over my 20-25 year horizon, which seems likely?
There is no way to know which is why there are so many "Should I pay off the mortgage threads" .

There is a wiki on this.

https://www.bogleheads.org/wiki/Paying_ ... _investing

A couple of things I would look at in your situation are;
1) Could you break even if you bought muni bonds? If so then you might invest the $100K in them and decide in a few years when the situation may be clearer.

2) It sounds like you have some young kids. Getting a 15 year mortgage might allow you to get the house paid off by the time they are in college.

3) If you are 40 then you might be investing with an asset allocation of somewhere around the old saying of "your age in bond". If you invest that $100k according to your asset allocation then you might be buying $40K in bonds. That makes it harder than it sounds to earn more than mortgage interest especially in a taxable account. You can juggle them around some but the taxes on any earnings of the $100k investment will tend to offset the advantages of the mortgage interest deduction.

(Disclosure, I paid mine off last week and posted about it and that thread is still going on.)
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tainted-meat
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Re: Mortgage Recast Question

Post by tainted-meat »

I am in the process of buying a home. Looked at 15 & 30 year rates of which both are incredibly low compared to historical averages. I decided to lever up and go for the 30 year. To get a fixed rate at 3.625 for 30 years is really incredible and most likely less than you would pay for a personal loan. If the market doesn't beat 3.625 over 30 years then we are all in trouble.
Topic Author
TCP
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Joined: Fri Jun 07, 2013 1:12 pm

Re: Mortgage Recast Question

Post by TCP »

It is "her" money and I've repeatedly told her since I dumped all of "my' money into the market she can do whatever she wants with "her" money. Doesn't mean I can't lobby her. This is something that either way won't have much of an impact on our lives.

The mortgage balance is about 620k. I will investigate refinancing to a 15 year.

Due to my income and job stability I have an aggressive age-20 in bonds portfolio. Almost all of them are in my 401k. I even have some stock index in my 401k that I could convert to bonds to avoid buying bonds in taxable. If we were to put this money into the market it would go 100% stock market index in taxable and would convert appropriate amount of stocks to bonds in my 401k.

I do have 3 girls, the oldest is 3. Looks like a 15 year mortgage might hit us right in the sweet spot. Although all 3 have 529s started so I'm hoping to not need a lot of cash flow to cover their college when that time comes.
orca91
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Re: Mortgage Recast Question

Post by orca91 »

dcd72 wrote:
orca91 wrote:Doing so also restarts the amortization schedule and most of your payments go to interest again.
No, that's a refinance. The entire point of recasting a mortgage is that it DOESN'T restart the amortization schedule.
Yes, it does. A recast starts the amortization over for however much of the term remains. It doesn't start the 30 years over, if that's what you thought I meant. But, the first bunch of payments are almost all interest again. Not so if you throw extra cash at the current mortgage. And, not cool to throw $100k toward a recast and still be paying mostly interest.. IMO.
harikaried
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Re: Mortgage Recast Question

Post by harikaried »

orca91 wrote:But, the first bunch of payments are almost all interest again. Not so if you throw extra cash at the current mortgage. And, not cool to throw $100k toward a recast and still be paying mostly interest.. IMO.
True that the proportion of a monthly payment towards interest is higher when recasting compared to paying extra principal without recasting, but the dollar amount of interest paid is still less than not making the extra principal payment.

Recasting provides the flexibility of having a lower monthly payment, but one could still pay the same monthly amount from before recasting.

E.g.,

Before extra principal payment, the monthly payments are $10 with $6 going towards interest and $4 towards principal.

After the extra principal payment and recasting, the monthly payments are $5 with $3 going towards interest and $2 towards principal. Without recasting, the $10 monthly payment would have $3 going towards interest and $7 towards principal.
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Watty
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Re: Mortgage Recast Question

Post by Watty »

TCP wrote:The mortgage balance is about 620k. I will investigate refinancing to a 15 year.
Be sure to check to see what the jumbo loan limit is in your area. It might make sense to pay it down enough so you could get a non-jumbo loan to get a better rate even if you had to dip into the money from the sale of your other house.
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jimb_fromATL
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Re: Mortgage Recast Question

Post by jimb_fromATL »

TCP wrote: Putting 100k down would reduce our monthly payment by approximately 460$/month. Multiplied by 12 months gives us saving 5,520$ in mortgage payments per year. Is this a guaranteed return of 5.5% for the length of our mortgage or am I overlooking something? I thought the return would be the mortgage rate, but the math seems to say otherwise? I feel like I'm missing something obvious, but I can't see it.

As always, thanks for your wisdom
The $460 per month lower payment is not earnings. It's actually just the payment of principal and interest at 3.625% that you are no longer be making on the $100,000 that you will no longer owe for the remaining 354 months.

The equivalent rate of return is indeed the mortgage rate of 3.625%. Actually, it a little better than the mortgage rate when compared to other investments, because you would be paying income tax on earnings in an investment, but there is no income tax on money that you choose to keep for yourself by not paying it out as interest to a lender. So the effective return is roughly the mortgage rate plus your federal and state tax rates on that gain.

... And the lower payment is not free money, either. As others have posted, if you recast and make the lower payment for the current remaining time it will cost you more interest than necessary in the long run.

Here are some numbers to illustrate what's been discussed:
  • As an example, if you owe $620,000 at 3.625% with 354 months (29.5 years) remaining, the payment is about $2854 per month for P&I. The total paid will be 354. x 2854.08 = $1,010,346 with $390,346 interest.

    If you pay down the balance by $100,000 and recast the new balance of $520,000 at 3.625% for the same 354. months the payment will be $2394 per month for P&I. That would be a $460 lower payment per month. That happens to be the payment on $100,000 at 3.625% for 354 months.

    The total remaining to be paid will be 354. x 2393.75 = $847,387 with $327,387 interest. Eliminating the compound interest on the $100,000 now will save you a total of $62,959 interest overall -- which is the interest for that time on the $100,000 you will no longer owe.
As others have also said, if you just pay down the balance by $100,000 and continue with the same payment of $2854 per month for P&I, you'll save a lot more interest and time in debt. If you do that, then the balance of $520,000 will be paid off in 265.01 months (22.08 years).

The total paid will be 265.01 x 2854.08 = $756,370 with $236,370 interest. Notice that the lower payment for the original time actually costs you $91,016 more interest and 89 more months in debt than necessary.

As for refinancing, it may depend on what amount qualifies for a jumbo mortgage in your area. According to bankrate.com, In my area the current rates on 15 year jumbo refi loans are around 4% ... which is higher than you have now. Plus you'd have to pay closing costs -- typically in the range of 1% or so of the balance on loans that size.

By the way, assuming you've already maxed all your tax-advantaged retirement investment space, the equivalent of earning just the mortgage rate after tax is still probably considerably more than you can earn in any other account that gives you an equally absolutely guaranteed rate of return with no risk to the principal. So it is a good place to put the money and be sure of the return on the investment.

The main problem is that it is somewhat like a high-paying CD or bond that you cannot easily cash out early if at all; and you don't really realize the return until you have the mortgage paid off earlier, or when you sell it earlier and have more equity with less total interest paid out by that time.

Another consideration:

SInce it costs so little, and the rate is already pretty good, there could be a good reason to recast anyway; but plan to continue making at least the current payment for P&I. This way you'll save the money as shown in the example above, but if for any reason times were to get tough financially, you'd have the option to drop back to the normal monthly payment so you'd have more room in your budget for other things.

jimb
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