How a rate-and-term refinance works and can save you thousands
Quick insights
- A rate-and-term refinance involves replacing your current mortgage with a new one. The new mortgage may have a lower interest rate, different terms or both. However, your principal remains the same.
- Rate-and-term refinancing can help lower your monthly payments, let you pay off the loan faster, change your loan type and save on interest.
- A cash-out refinance, on the other hand, increases your loan balance so you can take cash out of your home’s equity at closing. You can then use this cash to pay off debt or for other expenses.
If you’ve ever financed a home, you probably know that mortgage rates aren’t static. Even if you found the best rate possible when you purchased your home, you may be wondering how to take advantage of lower rates down the line. A rate-and-term refinance (also known as a no-cash-out refinance) allows you to obtain a new mortgage with new terms. There are a few reasons you might want to explore this type of mortgage refinance, from lowering your monthly mortgage payments to paying off your mortgage earlier. Let’s take a closer look at how rate-and-term refinances work, when they may be beneficial and how they differ from other types of refinancing.
How rate-and-term refinances work
Rate-and-term refinancing gives you the opportunity to replace your current mortgage with a new loan that has different terms, a lower interest rate, or both, while your principal stays the same.
Rate-and-term refinance requirements
Because you’re getting a new loan, you’ll once again have to meet lender requirements to qualify for a rate-and-term refinance. These could vary depending on the lender, but here’s a general list of mortgage refinancing requirements you may want to keep in mind:
- Credit score: Lenders often want you to have a fair or excellent credit score if you’re applying for a new loan, but this may vary depending on the lender and the type of pre-existing loan.
- Debt-to-income ratio (DTI): Your debt-to-income ratio is a measure of how much of your income goes toward your debts. If your DTI is low, it may signal to lenders that you can afford to take on a loan.
- Home equity: Lenders usually want to see that you’ve built up a certain amount of equity in your home before approving you for a rate-and-term refinance. Because the requirement varies between lenders, you may want to ask around to see what’s needed.
- Loan-to-value ratio (LTV): LTV weighs the appraised value of a home against the amount being borrowed. A high ratio may lead to lenders perceiving the loan as a riskier prospect.
- Closing costs: If you’re refinancing and considering a rate-and-term option, be aware that you’ll be responsible for the closing costs that come with the new loan. Some borrowers may be interested in a no-closing-cost refinance, which rolls that amount into your monthly mortgage payments, rather than a rate-and-term refinance.
Should you refinance your mortgage?
Industry experts project that mortgage refinance rates are expected to remain high (at least 6%) through 2026. Because of these higher rates, there are a few considerations to keep in mind.
To determine if refinancing makes sense, first assess your finances and credit. You want to make sure you can afford refinancing closing costs, and a recent dip in credit can affect the cost of your loan.
It’s also important to weigh your break-even period: the time it takes for refinancing savings to make up for the fees and costs. If you plan to stay longer than that period, you’ll recoup your investment and could save more if interest rates eventually fall.
Assessing these factors can help you make a more well-informed decision that works for your unique financial situation.
Benefits of rate-and-term refinance
Refinancing has several key benefits, even when rates are high. The advantages of rate-and-term refinancing in particular include:
- Lower monthly payments: Rate-and-term refinances can help you lower your monthly payments, potentially freeing up finances for other life expenses and goals. Be aware that this may lead to paying more interest over time.
- Save on interest: Opting for a lower interest rate could help you save money over the course of your loan.
- Pay off mortgage earlier: You can use a rate-and-term mortgage refinance to qualify for a new loan that has a shorter term. For example, your former loan may have had a 30-year mortgage rate, while your updated one has a 15-year mortgage rate. While this will likely increase your monthly payment, it may help you save in the long run.
- Change your loan type: Depending on its type, you may be able to change your loan from, say, an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. This could make your payments more consistent.
How to get a rate-and-term refinance
Here’s a step-by-step guide to the process of getting a rate-and-term refinance:
1. Assess your finances
Before applying, you may want to review your finances, from your current mortgage terms, interest rate and monthly payment to your income and credit score. This will help you decide if you want to change your rate, your terms or both.
2. Research lenders
Once you’ve got a clear goal in mind, it’s time to research lenders. Rates, terms and requirements may vary depending on the lender, so try to pinpoint the lenders who will work for you.
3. Get your documents in order
It may be a good idea to gather required documents ahead of the preapproval6 and application processes. Lenders will want to verify your income and see bank statements, tax returns and records of your original mortgage. Keep in mind that document requirements may vary from customer to customer and will be requested after a mortgage professional discusses each scenario.
4. Get preapproved
Getting preapproved may show lenders you’re serious about refinancing. They’ll do an initial evaluation of your paperwork before preapproving you for the new mortgage.
5. Submit your application
The next step is generally to submit your application along with all those documents you’ve gathered in advance. While rate shopping with multiple lenders can enhance your negotiating position, be mindful that each hard credit inquiry may temporarily affect your credit score. To mitigate this, conduct all applications within a short time frame, as credit bureaus often treat multiple inquiries for the same loan type as a single event.
6. Get a home appraisal
Once you’ve chosen a lender, received a loan estimate and locked in your rate, they’ll send an appraiser to your home to get a better idea of your loan-to-value ratio (LTV). Lenders may also want to do a house title search to make sure there aren’t any liens or judgments against you.
7. Study your closing disclosure
If all goes well, you’ll receive a closing disclosure that should finalize projected closing costs. Try to compare the disclosure with the original loan estimate to make sure you understand the terms before you sign.
8. Close on your loan
If the terms meet your expectations, you’ll meet with your lender to close on the loan. This will involve signing all relevant documents and paying your closing costs before celebrating your new terms.
Rate-and-term refinance vs. cash-out refinance
If you’re still on the fence about a rate-and-term refinance, there are other types of refinancing for you to explore. Another common option is a cash-out refinance. Let’s look at how this compares to rate-and-term refinancing.
Rate-and-term refinance
- Allows borrowers to qualify for a new loan that changes the rate and term of their mortgage.
- A rate-and-term refinance typically has lower credit score requirements than a cash-out refinance.
- With a rate-and-term refinance, you’re usually refinancing to take advantage of lower interest rates.
Cash-out refinance
- Enables borrowers to refinance into a higher principal balance, thereby extracting home equity as liquid funds for substantial expenditures such as renovations, education, or debt consolidation.
- Used for big purchases such as home renovations, weddings and college tuition.
- Credit score requirements are generally higher for a cash-out refinance than a rate-and-term option.
- Cash-out refinances usually have higher interest rates and monthly payments.
If you’re looking to refinance to raise funds for a big purchase and don’t mind a bigger mortgage, consider a cash-out refinance.
Rate-and-term refinance FAQs
1. How soon can you do a rate-and-term refinance?
While there is no federally-mandated waiting period for a rate-and-term refinance, accumulating at least 20% equity can improve your loan-to-value ratio, potentially qualifying you for more favorable terms and obviating the need for private mortgage insurance (PMI).
2. Who is eligible for rate-and-term options?
Lenders tend to look at your credit scores, debt-to-income ratio (DTI) and LTV. Contact lenders to find out their eligibility requirements.
3. What is the max LTV for rate-and-term refinance?
Lenders differ where max LTV is concerned. While some lenders require a maximum LTV of 80%, others may accept higher or lower. Contact mortgage lenders to compare their requirements and see where your LTV lies on the spectrum.
Can you pay off debt with a rate-and-term refinance?
You can’t directly pay off debt with a rate-and-term refinance because it only replaces your existing mortgage. This new loan has a different interest rate or term. It doesn’t provide extra cash beyond the current loan balance like a cash-out refinance.
However, by lowering your interest rate or extending your loan term, a rate-and-term refinance can reduce your monthly mortgage payment. In turn, this may free up monthly cash flow that you can then use to pay down other debts more aggressively.
In summary
Mortgage rates are fluid, and a rate-and-term refinance allows borrowers to use that to their advantage. With this type of refinancing, borrowers essentially get a new mortgage with better terms. This could mean reducing monthly payments, or, if you change the length of the mortgage, paying it off faster. Either option could increase your financial flexibility and save you money on interest, leaving you with funds to cover other exciting life expenses.
