Dropping a lump sum towards your mortgage won’t automatically lower your payments
If you’re one of the lucky few that’s got extra cash laying around and you’re thinking of paying down your mortgage early, you should know it’s not a short cut in reducing your payment. Unless you ask your lender to recast your mortgage, it won’t change your payment. That extra principal payment will reduce your interest charge over the life of the loan, but don’t count on having extra cash in your pocket every month. Before forking up a lump sum towards your mortgage, know your options.
Mortgage Recasting, What is it?
First, you’ll need to know the term amortization. It’s the action or process of gradual writing off the initial cost of an asset. Mortgage recasting is a lender re-amortizing the loan after the home owner provides a sizeable lump sum payment. For your payment to change, the loan must be re-amortized to show lower principal balance.
Ask your lender first!
Recasting your mortgage might not be an option. The lender isn’t required to and some loans aren’t eligible to recast mortgages; the takeaway? always ask first if your lender is willing to do so.
Consider alternatives for your cash
Current mortgage rates are very low and depending on your existing mortgage, it may make more sense to refinance your loan instead of recasting it. This may allow you to save on interest payments over the life of the loan and reduce your monthly while using the extra cash for other investments. Or, consider paying down the principal then refinancing the loan.
If your interest rate is low, expanding your portfolio by investing the extra cash may be an option. Consider your interest expense relative to your long-term expected returns; if a homebuyer has a 30-year fixed for 2.85% and their long-term assumption for investment returns is 6%, they would’ve used leverage in achieving better financial results. Let’s face it, it’s hard to enjoy the benefits of paying down your mortgage early until you’re living “debt-free, stress-free”.
Flexibility is all-important
If you’re one of those good-eggs who’ve saved diligently, or created a windfall by making sound stock moves or maybe you just inherited a large amount of money; homeowners who buy a new house before selling their old one may also consider using the proceeds from the sale to pay down their new mortgage. Most importantly, remember to discuss recasting your mortgage with your lender first before making any bank withdrawals.
Consider the flexibility in your financial decisions. If you decide to use the extra money to pay down your loan, it won’t be readily available for emergencies or other goals especially if you haven’t improved your monthly cash flows without a mortgage recast. Think of cash as opportunity and you’d want to ensure you’re making the most of it.