Recast Trigger
On the surface, option ARMs, or option adjustable-rate mortgages, look pretty neat. There’s a lot of flexibility with the payment options. For example, if we’re super short on funds one month, we can just make a super-low minimum payment, or just pay the interest due. That can be a lifesaver in times of financial stress. Buuuut if we do that too many times, that lifesaver can turn into a life-sized pile of stress, especially if we find ourselves in a recast trigger situation.
A “recast trigger” is a threshold or criterion that, once met, causes our mortgage to automatically modify its terms and recast its payment plan. And not in a good way.
Let’s get back to that option ARM we were so happy about earlier. Let’s say we initially borrowed $400,000 to buy a house, and at first we were making our full payments no problem. But then, for whatever reason, we started only paying the interest due, or maybe that plus a little bit more. We had extra money in our pocket every month, but we weren’t doing anything to decrease our loan principal. In fact, our payments have been so small for so long that we’ve actually added to the principal amount: we now owe $440,000 on a $400,000 loan that we’ve had for five years. That’s no bueno.
And even less bueno is the fact that our mortgage came with a recast trigger clause. If our amount owed exceeds 110% of the original amount borrowed (most recast triggers go off between 110% and 125% of the loan amount), then our mortgage will automatically reset. According to the terms of our loan, we’ll essentially be starting over with a $440k loan, but this time, our timeframe is shorter: since we’re already five years into a 30-year mortgage, we now only have 25 years to pay off our new amount owed. And our interest rate is going to be higher. Guess what that means? That’s right: our monthly payments are going to be even higher than the payments we weren’t making before.
This is one of the reasons option ARMs can be so dangerous. If we were having trouble making our full payments before, then we’re probably going to have an even harder time now that the payments are higher. This increases our risk of defaulting on the loan. And that would be the least bueno thing of all.
Related or Semi-related Video
Finance: What is Interest Only Mortgage?17 Views
Finance allah shmoop what is an interest only mortgage Well
simply put it's when you only pay the rent on
the dough you borrowed you don't pay down the principal
you owe like if you have a three hundred thousand
dollars mortgage at six percent interest you're paying eighteen grand
a year to rent that money in six percent times
three hundred rands eighteen grand a year But the principal
you borrowed is likely due in thirty years So in
theory anyway if it were a normal mortgage you'd want
to pay down the principal little bit a month as
you go along like averaging ten grand a year in
principle pay down over thirty years That's times ten grand
right three hundred grand their total owning your home at
the end yeah yeah priceless that's what holmes work So
why would you want an interest only mortgage Well for
one thing the monthly payments or less so maybe you
could afford morehouse If on a thirty year three hundred
thousand dollar loan at six percent you're paying interest only
while you're writing a check each month for eighteen thousand
divided by twelve or fifteen hundred bucks maybe that's all
You can afford well the extra five hundred bucks arm
or you'd right toe pay down your principles Just not
something you can really do right now Maybe after three
years of scrimping and saving well you'll be able to
start paying down that principal reducing risk and making life
easier all the way around But right now you can't
afford it so the only thing you can do is
do the interest only dance Well the other reason you
might want an interest only mortgages that interest costs are
tax deductible Principal pay down costs are not so if
in a given mortgage payment of say eighteen hundred bucks
a month where three hundred of it is principal pay
down and fifteen hundred of it is interest well on
ly the fifteen hundred is tax deductible That three hundred
of pay down is not And if you're a forty
percent taxpayer the government is essentially picking up the tax
savings on the fifteen hundred times a forty percent at
six hundred dollars in interest You're paying such that they
quote feel unquote like the fifteen hundred is really only
about nine hundred a month in cost to you the
three hundred bucks and principal paydown feels like a full
three hundred dollars So some people seeking tio optimize their
tax deductions live in the world of interest only mortgages
and let the government for a change You know work 00:02:26.24 --> [endTime] for them How's that feel same all Take it
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