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 Adjustable-Rate Mortgag...17 Views
Finance allah shmoop What is adjustable rate mortgage or arm
Well here's an arm and here's a leg and that's
What Renting the money to buy a home costs you
Yeah Okay Eight r m stands for adjustable rate mortgage
The rate well that's The interest cost of the money
or the cost of renting that money to buy the
home Well the rate isn't it fixed in this case
like five point seven percent for thirty years Where you
know in advance that your monthly payments going to be
nine hundred forty three bucks a month or whatever it
is that would be a fixed mortgage a fixed number
You can count on it for all three hundred sixty
payments And then the house is all yours So that's
fixed then what's adjustable like yes the interest rate changes
But how does it change Well in a standard arm
there is some global standard on which the rates are
often price like lie bore the london interbank borrowing offering
rate It's one of the key things that price is
the cost of renting money all around the world with
the actual rate of libel or is generally reserved for
banks like super cheap cost of renting money to banks
who are very likely to pay back the money with
no hassle that rate is more or less what banks
pay for running the money along with blue chip customers
in real life The banks then mark up a premium
on top of the rate that they're paying to rent
the money to themselves And then they resell or re
rent that money teo their prized customers So the pricing
of bank my views in renting money to joe six
pack could be something like lie boer plus three percent
or three hundred basis points So if libel or is
it didn't say two and a half percent today the
adjustable rate might be five and a half percent and
all that's great honor given alone It might mean that
for a while you're paying seven hundred twelve dollars a
month for your house payment wonderfully cheap and in fact
banks market these low rates initially to help people be
able to afford tto by that new home and live
of the dream You know the american dream usually with
an arm there's a teaser rate that starts really low
Like at live or live or plus ten basis points
or something like ridiculously cheap for six months or a
year something like that Then it has an incremental set
of step ups in interest costs and venit adjust with
the markets usually upward maybe upward by a lot Remember
there's a reason it's called a teaser rate but then
if we get inflation or a you know just bank
nervousness for there are weird effects from brexit or the
volume of transactions going through london or something weird happens
Well then the liquidity drops and interest rates rise So
now lie board goes up and up and up to
four and a half percent and wealth contractually in your
mortgage paperwork you have to pay live or plus three
hundred basis points no matter what So now that's seven
and a half percent interest on the dough you borrowed
and well we're that toe happen It's likely that your
monthly payment has skyrocketed from seven hundred twelve dollars a
month is something more like twelve hundred dollars a month
or more Can you handle that big of a payment
Well have you done a fixed rate loan at nine
Hundred forty three dollars a month Well you'd still be
paying on that number but you rolled the dice with
an arm and now you owe big bills There go
that arm and a leg thing we warned you about 00:03:26.033 --> [endTime] eh
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