The purpose of this blog is not to analyze whether or not mortgage debt can be a useful financial tool (it can). We will deal with the pros and cons of mortgage debt in another article. In this blog we assume that you have decided that you would like to reduce or shorten your mortgage and we discuss some popular ways of doing that.
With thirty-year mortgage rates dipping below 4% again recently, many homeowners are wondering what, if anything, they should be doing with their home loans. Maybe you’ve been prepaying it and you wonder if recasting or refinancing is right for you? Following is an introduction to these options, and as always you can contact your HCM Wealth Advisor to learn more.
Let’s say you’re considering prepaying your mortgage. Maybe you’re able to pay extra every month, or maybe you have some extra cash available. If you prepay your mortgage, you’re effectively purchasing a taxable “guaranteed” bond return with a yield. Whether or not this is a good investment will depend on your time horizon, tolerance for risk and tax bracket. It is also important to remember that you won’t realize any material benefits for years, maybe decades.
To realize these savings now, a mortgage recast is in order. A mortgage recast recalculates the remaining payments based on a new amortization schedule. Let’s say you’re 5 years into a 30 year mortgage of $400,000 at 4%, making the current payment $1,910. At this point you receive a hypothetical $50,000 bonus, which you apply to the mortgage. Recasting would lower your payments to $1,646, providing an immediate cash flow advantage. These new payments will stretch over the remaining life of the loan. Note that you don’t have to stop making your old payment if it is in the budget as doing so will pay your mortgage off early. Recasting the mortgage gives you the option to make a reduced payment and use the new free cash flow for other purposes.
Instead of recasting, you may be interested in refinancing your mortgage. Refinancing involves paying off the existing loan and replacing it with a new one. Refinancing can be done to obtain a lower interest rate, shorter or longer term, or convert to a different type of loan (from adjustable to fixed-rate, or vice-versa).
There are pros and cons to both approaches. For a recast, you don’t need to apply for a new loan, so there’s no credit check, no need for proof of income, etc. However, not every type of mortgage is able to be recast; FHA and VA generally don’t qualify for recasting, and the ability to recast jumbo loans varies from lender to lender. Usually, refinancing will cost more than a recast due to the additional closing costs on the new loan.
The choice between whether to prepay, recast, or refinance your mortgage can be complicated as it involves tax and cash flow and portfolio considerations. The decision needs to be built into the design of your holistic wealth plan. Feel free to reach out to your HCM Wealth Advisor to schedule time to discuss this and any other pressing financial topics you may have.