What Is a Recast Loan?

A mortgage contract may not initially require the homeowner to make payments that are large enough to pay off the principal of the mortgage. When a bank offers a mortgage under this condition, it includes a recast term in the contract. When the terms for the recast are met, the minimum mortgage payment increases so future payments will cover the loan principal.

Some loan recasts occur after a certain period of time passes. The bank offers a mortgage contract that grants the homeowner the right to decide at first how much money to pay each month, but after a few years, the homeowner must send the full payments. When a recast is time-dependent, the homeowner receives advance warning that the size of his mortgage payment is going to increase. According to the Wharton School of Business, five years is a typical recast period.

The recast can also trigger when the homeowner does not have enough home equity. This type of recast is less predictable for the borrower because a fall in the market value of the house can cause a recast. If the home value drops from $500,000 to $400,000, a recast may occur, and the homeowner may not have several months to prepare for a higher mortgage payment if the real estate price drop is rapid.

A recast can surprise a homeowner who takes out a loan that begins with fixed monthly payments. For example, the bank may require the homeowner to pay $3,000 each month. If the interest rate rises and the mortgage has a variable rate, the bank may allow the homeowner to continue paying $3,000 each month, even though the sum of the interest and principal payments is now $3,500, according to the Loyola Law Review. The homeowner may not realize she is not making the full payment and the mortgage balance is rising by $500 each month.

Recasts typically involve riskier borrowers. If the borrower could not afford to make the full mortgage payments before the recast, she is not likely to have enough income to make the payments after the recast. The Loyola Law Review states that payment caps, which normally restrict the amount that the mortgage payment can rise from month to month, do not affect recasts. A $3,000 payment could change to a $4,500 payment after the recast, which might cause the homeowner to default.

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