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.