If you have extra cash and are considering repaying your mortgage early, be aware that this will not automatically reduce your payment. Adding extra money to your mortgage will only change your payment if you ask the lender to rewrite your mortgage. If you don’t rewrite your mortgage, the additional principal payment will reduce your interest expense over the life of the loan, but will not put extra money in your pocket every month. Before you commit a lump sum on your mortgage, you should understand your options.
What is a Mortgage Recast?
A rewrite of the mortgage occurs when a lender repays the loan after the homeowner pays a large lump sum. In order for your payment to change, the loan must be revalued according to the lower principal amount.
Here is an example:
For example, let’s say you buy a home and take out a 30 year loan of $ 500,000 at 3% interest. Your monthly payment is approximately $ 2,100. In five years you have extra cash and decide to use $ 100,000 on your mortgage.
Without rewriting your mortgage, your payment will be unchanged as the amortization schedule is still based on the original $ 500,000 mortgage. With the lump sum payment, however, you can repay the loan much faster: in around 22 ½ years instead of 30.
If you rewrite your mortgage, after the payment the lender will use your adjusted principal of approximately $ 345,000 and create a new amortization schedule for the remaining 25 years of the mortgage. Your new monthly payment would be approximately $ 1,635, which is a saving of $ 465 per month.
Recast your mortgage may not be an option
Before you make a large one-time payment on your loan, ask your lender if they are ready to rewrite your mortgage. There is no obligation on the lender to do so, and some loans are ineligible so it may not be an option. You should understand the process and know if this is possible before making any additional payments on your loan.
Consider your alternatives for the money
Refinance Your Mortgage
Mortgage rates are currently very low. The average interest rate on a 30 year fixed rate mortgage at the time of this writing is 3.06%. Depending on the interest rate on your existing mortgage, this may make more sense Refinance your loan instead of rewriting it. This could allow you to save interest expenses over the life of the loan and reduce your monthly payment while you use the money on other investments. Alternatively, you can consider paying back the principal amount and Refinancing the loan.
Instead, invest the money
If you have excess money burning a hole in your pocket, consider this Opportunity cost of paying back your mortgage early rather than using the funds to invest elsewhere. While you will save some of the interest expense, it may be better to invest the money instead, especially if your interest rate is low.
Consider your interest expense in relation to your long-term return expectations. If a homebuyer can get a 30-year fixed-rate mortgage for 2.85% and their long-term investment return assumption is 6%, they are using leverage to get better financial results. After all, you won’t get the benefits of early mortgage repayment until you live debt free, but the average buyer only lives in the home for 10 years.
Flexibility is valuable
It is very common to think about repaying a mortgage early. Perhaps you inherited money, saved diligently, or created a godsend by selling stock options. Homeowners who Buy a new house before selling the old house might also consider that Proceeds from the sale to repay the new mortgage. Again, unless your lender agrees to rewrite your mortgage, your payment will not change.
While figuring out the numbers is good practice, the value of flexibility should be considered in your decision. If you use the money to pay off your loan, it won’t be immediately available when you need it for other purposes, and you haven’t improved your cash flows every month without a mortgage recast.
Building equity in your home is good, but you do so with every mortgage payment. It is desirable to fully own your home and be mortgage free. But make sure to make the most of the opportunity the money presents you.