What Is A Rate-And-Term Refinance?

Are interest rates lower now than when you originally got your mortgage loan? Maybe you want to change your term to lower your payment or pay off your loan faster. A rate-and-term refinance could be your key to both.

The Basics Of A Rate-And-Term Refinance

A rate-and-term refinance, sometimes called a rate-and-term option or a no cash-out refinance, allows you to change the terms of your current loan, replacing it with terms that are more favorable.

Refinancing means paying off your previous mortgage and making payments on a brand-new home loan. A rate-and-term refinance allows you to lower your payments, change your term or both with the goal of savings. For instance, taking a longer term means saving on monthly payments while shorter terms mean paying less interest on the loan.

The other common type of refinance, a cash-out refi, allows you to convert your home value to cash by taking on a bigger loan. With a rate-and-term refi, your mortgage balance isn’t touched.

Benefits Of A Rate-And-Term Refinance

Homeowners can take advantage of several benefits of a rate-and-term refinance. Let’s take a look at some of the most common reasons homeowners choose to take this step.

Lower Your Interest Rate

If current interest rates are lower than when you first got your loan, you may be able to get a lower one. You might also qualify for a lower interest rate if you have a better credit score or more equity now than when you got your original mortgage.

Because mortgages involve high loan amounts, even the difference of a few tenths of a percentage point in the rate can make a difference in the monthly payment and lifetime cost of the loan.

Reduce Your Monthly Mortgage Payment

You might choose a rate-and-term refi if you want lower monthly payments. This is often a pleasant side effect of a longer term or lower interest rate. Your monthly payment tends to go down when you refinance a mortgage to a longer term because you give yourself more time to pay off your loan while making more overall payments.

Refinancing to a longer term and reducing your monthly payment make your payment more manageable. Keep in mind that refinancing to reduce your mortgage payment could mean you’ll end up paying more in interest if you get there by lengthening your term.

Modify Your Term Length

You can also refinance your mortgage loan to a shorter term, such as refinancing to a 15-year mortgage from a 30-year mortgage. Doing so increases your monthly payment, but you end up paying much less in interest over the course of your loan. This can mean tens of thousands of dollars saved by the time your loan matures.

When it comes to conventional fixed-rate loans, you can customize your term to find one that works for you. Our YOURgage^® lets you pick from term options anywhere between 8 – 30 years.

Are you now earning more in income than when you got your loan? Refinancing to a shorter term can help you own your home sooner.

Change Your Loan Type

With a rate-and-term refinance, you might also be able to change the type of loan that you have. For example, you may be able to refinance an adjustable-rate mortgage (ARM) into a fixed-rate mortgage to provide more payment certainty. You might also switch from an FHA loan to a conventional mortgage to drop mortgage insurance.

How A Rate-And-Term Refinance Works

When you do a rate-and-term refinance, you’re replacing your existing mortgage with a different one. You’ll have a different rate and could end up with a shorter or longer term. These changes impact the amount of your monthly payment and the interest you pay over time.

Understanding Loan Replacement

To break this down, let's take a look at a couple of examples. In one, we’ll shorten the term, and one will be longer. Both of these payments don’t account for taxes and insurance, but they will give you an illustration of how replacing your own loan with a new one impacts your costs. You can put in your own numbers with our amortization calculator.

First, let’s take a look at a 15-year fixed term for a $350,000 loan with a 6.5% interest rate. The monthly payment is $3,049. If the loan is paid off according to the schedule, you would pay $198,798 in interest on top of the balance.

Now let’s take a look at a loan with the same balance, but a 30-year term. We’ll also change the interest rate to 7%. Interest rates for longer terms tend to be higher because investors need a higher yield to account for increased inflation over the life of the loan. You also pay more interest in general no matter the rate for a longer-term. 

The monthly payment on a $350,000 loan with a 30-year term at 7% is $2,329, a significant savings. But you pay $488,281 in total interest. 

Limited Equity Withdrawal

Although there are instances in which you may receive cash back at closing, never more than $2,000, the purpose of a rate-and-term refinance is never to convert your existing equity in the home into cash. It’s all about obtaining a better rate and/or a more manageable payment.

If you’re looking to put the equity in your home to productive use, possibly to consolidate debt or make home improvements, you’ll want to look into a cash-out refinance or home equity loan.

Rate-And-Term Refinance Requirements

When you refinance, you apply for a new loan. The criteria used by lenders should feel very similar to those used when you bought your home. 

Let’s take a look at some of the mortgage refinancing requirements to adjust your mortgage interest rate or term.

Credit Score

Refinances have minimum credit requirements that vary by loan type. Most lenders require a credit score of at least 620 to qualify for a refinance for a conventional loan.

Do you have an FHA loan? These types of loans have a median minimum qualifying score of 500, though most lenders set their own requirements. For example, Rocket Mortgage^® requires a minimum credit score of 580 for FHA loans. This enables us to offer you better loan terms based on a higher credit score. In fact, because your credit score is closely tied to the interest rate you receive, the higher the better.

If you have a VA or FHA loan, you may want to consider a VA Streamline refinance or FHA Streamline refinance, respectively. These loan options often allow you to move forward without an appraisal and may require less documentation. They also have lower mortgage insurance or funding fee costs.

Home Equity

Your home equity is the percentage of the loan principal you’ve paid off. The more equity you have, the lower your interest rate may be because the lender considers you a lower risk based on the smaller balance.

If you’re getting a conventional loan, there is the additional benefit of not having to pay for private mortgage insurance (PMI) if you refinance after you’ve reached 20% equity. On FHA loans, mortgage insurance premiums are removed after 11 years if you have 10% equity in the home when refinancing.

Debt-To-Income Ratio (DTI)

Lenders also consider your DTI when they look at your refinance application. Your DTI compares your recurring monthly debt payments to the amount of money you have coming in. It can be calculated by dividing your monthly minimum debt payments by your monthly earnings before taxes.

Aim for a DTI of 43% or lower before you apply to refinance. FHA and VA loans sometimes allow you to qualify with higher debt ratios, but having a lower DTI will allow you to qualify for the most options.

Closing Costs

You’ll need to account for closing costs when you refinance your mortgage. Closing costs for a refinance usually range from 3% – 6% of the principal balance on your loan. Every situation is different.

If you can’t cover closing costs upfront when you refinance, you may be able to roll them into your new loan with a no-closing-cost refinance. You do this by taking a higher rate from the lender so they pay the closing costs.

How To Get A Rate-And-Term Refinance

Applying for a refinance is similar to applying to buy a home. You’ll submit an application to your lender along with some financial documentation. Your mortgage lender will then begin underwriting, the process of making sure you qualify for your new mortgage. They’ll also schedule a home appraisal and give your anticipated closing date.

Do you think a rate-and-term refinance might be right for you? Here’s more information on what you can expect from the process.

1. Apply For The Mortgage Refinance

The first step in any refinance is to apply with your lender of choice. Research lenders in your area and consider current mortgage interest rates. You also have the option to refinance with your current mortgage lender. Submit an application to your chosen lender and specify that you want to refinance your rate and/or term.

You can shop around and apply with multiple lenders up until you sign an intent to proceed with one of them. They’ll send you a document called a Loan Estimate so you can easily compare terms. You’ll want to do all your shopping within a 14-day window so that it all counts as one inquiry on your credit report. This way, any drop in your score based on the inquiry will be minimal.

Your lender will ask you for a few important financial documents when you apply for your refinance, including your:

• Two most recent pay stubs
• Two most recent financial account statements
• Two most recent W-2s

You may need to provide additional documentation if you’re self-employed. Have your paperwork in order before you apply for a faster refinance.

Your lender will begin the underwriting process once you submit your refinance application. Your lender verifies your income and assets during underwriting and makes sure that you qualify for a refinance. Respond to all lender inquiries during this time to help keep your refinance on track.

2. Lock In Your New Rate

Your lender will give you a Loan Estimate after you apply for your refinance. Your Loan Estimate gives you an estimate of the fees and costs associated with your new loan. Hang onto this document – you’ll need to compare it to your Closing Disclosure later on.

You’ll also have the option to lock in your mortgage rate. Interest rates change daily. When you lock your rate, you protect yourself from interest rate changes that occur between your refinance application and closing. Most lenders allow you to lock your rate for 15 – 60 days. Because lenders hedge against market risk when locking your rate, the longer your lock timeframe, the higher the fee associated with it.

3. Get An Appraisal

Your lender will also schedule a home appraisal to determine your home’s value. Appraisals are important because they assure your lender that they aren’t giving you more money than your home is worth. You’re free to attend the appraisal when you refinance because you already own the home. Make sure your property is in the best condition possible before the appraiser arrives.

If you’re opting for a certain type of refinance like a VA or FHA Streamline, you may be able to skip the appraisal requirement. A lender may also be able to rely on other methods of valuation that may not need a full appraisal.

4. Review Your Closing Disclosure

Your lender will issue you a Closing Disclosure 3 business days before your closing. Your Closing Disclosure contains important details about your new mortgage. You'll find your principal balance, interest rate and monthly payment. Read through this document carefully and make sure the terms match up with the refinance you want.

If you’re refinancing to a longer loan term. Odds are your monthly payment is lower than your current payment. Are you getting a lower interest rate? Your monthly payment should be lower if the term is the same or longer. Compare your new Closing Disclosure with the terms of your current loan and make sure all of the information matches your conversations with the lender.

5. Close On Your New Loan

Once your lender finishes underwriting, it’s time to close on your loan. After you read your Closing Disclosure and make sure the terms are correct, contact your lender and acknowledge that you’ve received it. Delays in acknowledging the Closing Disclosure can push back your closing date.

At closing, you’ll ask any last-minute questions you have about your new loan and sign all the necessary paperwork. Bring along your photo ID, your Closing Disclosure and a proof of transfer or a cashier’s check to cover your closing costs. Your lender will appoint a neutral third party to conduct the closing and finalize your refinance.

Rate-And-Term Vs. Cash-Out Refinance

You don’t need to change your rate or term when you refinance – you can also take money out of your home equity with a cash-out refinance. You accept a higher principal loan balance and take the difference out in cash with a cash-out refi.

Let’s consider an example.

You owe $100,000 on your existing mortgage. You want to do $20,000 worth of upgrades on your home, so you take a cash-out refinance. At closing, you sign on a new loan worth $120,000 and your lender gives you $20,000. Many homeowners use this money to consolidate debt, fund home improvements or boost their retirement savings.

Let’s take a look at some of the similarities and differences between rate-and-term refinances and cash-out refinances.

Similarities Between Rate-And-Term And Cash-Out Refinance

Some of the similarities between rate-and-term refinances and cash-out refinances include:

• You take out a new loan. Both cash-out refinances and rate-and-term refinances involve paying off your existing mortgage as well as taking on a new loan with different terms.
• You can work with a new lender. Whether you take a rate-and-term refinance or a cash-out refi, you have the option of working with a new lender. You don’t need to refinance with the lender that gave you your current loan.
• You can change your rate or term. In addition to adjusting your principal, it’s possible to change both your interest rate and loan term when you take a cash-out refinance, as well as converting your equity into cash.
• Differences Between Rate-And-Term And Cash-Out Refinance
• There are also a few important differences between rate-and-term refinances and cash-out refinances.
• Your principal balance might not change. No matter how you change your term or interest rate with a rate-and-term refinance, your principal balance could remain the same if you didn’t roll your closing costs into your loan. When you get a cash-out refinance, you accept a higher principal balance and take the remainder out in cash.
• You take cash after closing. You’ll receive cash a few days after closing when you get a cash-out refi. You usually don’t receive any cash from your lender when you get a rate-and-term refinance.
• There are home equity requirements. You must have a minimum amount of equity in your home before you qualify for a cash-out refinance. For example, you may want to take $50,000 out of your home equity and have at least $60,000 in equity to draw from. This requirement doesn’t apply to rate-and-term refinances. 

As an alternative, you might not choose to refinance at all. Instead, it might be better to keep your existing mortgage and take out a home equity loan to accomplish your goals. A Home Loan Expert can help you with a blended rate calculation to see if it makes sense to take a second mortgage rather than do a new primary mortgage, based upon the interest rates and loan balances involved. Just know this means two mortgage payments.

The Bottom Line: A Rate-And-Term Refinance Can Better Your Finances

Rate-and-term refinances and cash-out refinances are for different types of borrowers. If you’re unsatisfied with your current monthly payment or interest rate, a rate-and-term refinance might be right for you. Do you want to consolidate debt or cover a major expense? You might want to consider a cash-out refinance or home equity loan.

If you’re ready to apply to refinance, start your application online today with Rocket Mortgage.