What Is a Rate-and-Term Refinance?

Refinancing is a time-tested financial move that can lower your mortgage payments by securing a new loan with a lower interest rate or a different term. It's the smart thing to do when rates drop, allowing you to save money or pay off your home sooner. But what exactly is a rate-and-term refinance and how can it benefit you? This comprehensive guide will explore rate-and-term refinancing in finer detail, helping you understand when it makes sense and how to manage the process effectively.

What Is a Rate-and-Term Refinance?

A rate-and-term refinance is a mortgage refinancing option in which you replace your existing loan with a new one that has a different interest rate, loan term, or both without borrowing more money. It's designed to make your mortgage more manageable or cost-effective based on your financial goals and market conditions.

How Does a Rate-and-Term Refinance Work?

In a rate-and-term refinance, you take out a new mortgage — often a lower interest rate or a different loan term — that replaces your existing loan. The new loan pays off the old one and you start making payments based on the new agreement. This arrangement doesn't change your principal amount but can significantly change your repayment schedule and interest expense.

Imagine you have a $300,000 mortgage at a 6.5% interest rate with a 30-year term, resulting in monthly payments of approximately $1,896. If rates drop and you refinance to a 4% interest rate with the same term, your new monthly payment could be around $1,432, saving you money each month. Alternatively, you could choose a 15-year term with higher monthly payments but a quicker payoff.

When Should You Consider Rate-and-Term Refinance?

Consider a rate-and-term refinance when:

• Interest rates have dropped: If rates have dropped since you took out your original mortgage, you can secure a lower rate and save money over the loan term.
• Your financial situation has improved: In this case, you can refinance to a loan with a shorter term as you can afford higher monthly payments.
• You prefer more predictable payments: A rate-and-term refinance can let you switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage for more predictable payments.

Pros and Cons of Getting a Rate-and-Term Refinance

Refinancing is a great way to save significant sums of cash, but it may not be everyone’s cup of tea.

Pros

• Lower interest rates: Can reduce your monthly payments and total interest paid over the life of the loan.
• Switching loan types: Move from an ARM to a fixed-rate loan for predictable payments.
• Term adjustment: You can pay off your mortgage faster or extend the term for lower monthly payments.

Cons

• Closing costs: Refinancing involves fees such as application fees, appraisal fees, title insurance and possibly others that can add up, sometimes 2-6% of the loan amount.
• Longer loan term: Extending the loan term to lower your monthly payment could mean paying more interest over time.
• Break-even point: It may take time to recoup the costs of refinancing through savings on interest, especially if your new rates are not significantly lower than your current rate.

What Are the Rate-and-Term Refinance Requirements?

To qualify for a rate-and-term refinance, lenders typically look at:

Home Equity

You'll need equity in your home, often at least 20%. The higher your equity, the better rates you can attract.

Credit Score

Lenders typically look for a credit score between fair and excellent. The exact credit score requirement varies depending on the existing loan type and your lender. Overall, a higher credit score can help you secure a lower interest rate.

Debt-to-Income Ratio (DTI)

Lenders prefer a DTI below 36%, though some may allow up to 43%. DTI measures how much of your income goes toward your debt payments. A lower DTI signals to lenders that you can comfortably take on the new loan.

Closing Costs

Be prepared to pay closing costs, which include application fees, appraisal fees, title insurance, and other expenses. Luckily, you can opt for a no-closing-cost refinance, which incorporates these costs into the monthly mortgage payments.

How to Get a Rate-and-Term Refinance

To secure a rate-and-term refinance, follow these steps:

Shop Around and Get Quotes From Multiple Lenders

Start by comparing rates and terms from different lenders to find the best deal possible.

Gather Required Documentation

Collect financial documents like pay stubs, W-2s and bank statements to prove your income and assets. These documents can fast-track your application and show your financial stability to lenders.

Apply With the Chosen Lender and Provide All Necessary Information

Complete the application process and provide all requested information to your lender of choice.

Lock in Your New Rate

Once you find a favorable rate, lock it in for a set period, typically 30 to 60 days. This rate lock protects you from rate fluctuations while your loan is being processed.

Get an Appraisal of Your Home's Current Value

The lender will require an appraisal to determine your home's current value. This information helps them assess the loan-to-value ratio, determining your eligibility and interest rate.

Review the Final Loan Estimate and Closing Disclosure

Carefully review all loan documents and understand the terms before signing. These documents usually contain the loan estimate and closing disclosure, which outline the terms of your loan, including the interest rate, monthly payments, and closing costs.

Close on the New Loan and Start Making Payments

Once the paperwork is completed and you’ve agreed to the terms, you’ll pay the closing fees (if applicable) and close the new loan. After closing, your new loan will be in effect and you'll begin making payments based on the new terms.

Find the Best Refinance Companies Benzinga’s Top Providers

Benzinga’s curated list of top providers offers an excellent starting point if you're searching for the best refinance companies. Here’s a concise overview of some of the top refinance mortgage companies distinguished in various categories to meet diverse refinancing needs. 

Rate-and-Term vs. Cash-Out Refinance

A rate-and-term refinance allows borrowers to adjust their mortgage’s interest rate and term without altering the loan amount, aiming for more manageable payments or a shorter loan duration. Conversely, a cash-out refinance allows homeowners to take out a new, larger mortgage, receiving the difference in cash to fund significant expenses. The former is chosen to improve the existing mortgage’s affordability based on current financial circumstances and market rates, while the latter is used to tap into home equity for large-scale investments or expenses. 

Tune Up Your Mortgage with Rate-and-Term Refinancing

Rate-and-term refinancing can be a powerful tool to make your mortgage more manageable and cost-effective. Key benefits include lower total interest payments over the loan's life and predictable payments with a switch from adjustable to fixed-rate mortgages. However, consider potential drawbacks such as closing costs and extended loan terms, which can affect long-term savings. By understanding the process, requirements and potential benefits, you can take a calculated stance that fits your financial goals and market conditions.

Frequently Asked Questions