- A rate-and-term refinance replaces your original mortgage with a new one.
- Your interest rate, monthly payments, and term length could change.
- You'll need a certain credit score, debt-to-income ratio, and equity stake to qualify.
- See Business Insider's picks for the best mortgage refinance lenders »
What is a rate-and-term refinance?
With a rate-and-term refinance, you exchange your current mortgage for a new one with different terms. You'll get a new interest rate and term length, hence the name "rate-and-term."
Your monthly payment amount will also change because a) you're paying a different amount toward interest each month, and b) refinancing into a longer or shorter term will affect how much you pay monthly. Multiple types of mortgages offer rate-and-term refinances, including conventional, FHA, VA, and USDA loans.
You may sometimes hear a rate-and-term refinance referred to as a "no-cash-out refinance," as you can't use these to turn your home equity into cash. That would require a cash-out refinance instead.
Benefits of a rate-and-term refinance
Refinances can often be a smart move — if done at the right time. Here are just a few of the benefits of rate-and-term refinancing.
Potential for lower interest rates
A lower interest rate is potentially the biggest benefit of a rate-and-term refinance. If mortgage rates have dropped since you first took out your loan, refinancing could allow you to get a lower interest rate.
This would mean less interest paid each month (i.e., a lower payment), and it could save you thousands over the life of your loan.
Opportunity to change the loan term
Rate-and-term refinances also let you choose a different term for your new loan. So, instead of a 30-year mortgage term, you could refinance into a 15-year mortgage. This would allow you to pay off your loan balance sooner and with significantly less interest.
If you refinance into a shorter term, you'll also own your home outright sooner. Just be prepared to potentially pay more each month to do it.
Possible monthly payment reduction
Since rate-and-term refinances can give you a lower interest rate, they could result in a lower monthly payment, too. Additionally, if you refinance into a longer term, your payments will drop even more significantly. (Although it would then take you longer to pay off your home.)
You also may be able to remove private mortgage insurance from your payments by refinancing. This only happens if you have at least 20% equity in your home — meaning your total mortgage balance is 80% or less of your home's value.
How to qualify for a rate-and-term refinance
Qualifying for a rate-and-term refinance isn't always easy. You'll need a decent credit score, equity in your home, and to meet other certain criteria.
Eligibility criteria
The exact criteria you'll need to meet will depend on the lender and loan program you choose, but generally speaking, here are the requirements you can expect:
- Home equity. Many lenders want you to have at least 20% equity in your home.
- Credit score. The minimum credit score will depend on which type of mortgage you are refinancing. A conventional mortgage requires at least a 620 score; FHA loans allow scores down to 500 in some cases.
- Debt-to-income ratio. The DTI ratio you'll need also depends on which type of mortgage you have. Most lenders will be happy if your ratio is 36% or lower.
There's some flexibility with these requirements. For example, a lender may approve you to refinance with a higher DTI ratio if you have an excellent credit score or more than 20% equity.
Required documentation
The documents you'll need for a rate-and-term refinance are the same ones you needed when initially applying for your mortgage loan.
You will need:
- Income documentation, including W-2s, 1099s, pay stubs, and Social Security statements
- Tax returns from the last two years
- Copies of your driver's license, state identification card, or Visa
- Bank statements for the last two months
- Proof of your homeowners insurance policy
- Statements for any retirement or investment accounts
Your lender may require other documentation, too. Ask your loan officer about what documents you should prepare before you file your application.
When to consider a rate-and-term refinance
Rate-and-term refinances can be beneficial, but they're not right for every homeowner. These considerations can help you determine when to refinance your mortgage.
Market conditions favoring refinancing
Market conditions play a big role in whether a rate-and-term refinance makes sense. Since you're replacing your current loan with a new one — and more importantly, a new interest rate — being aware of market interest rates is critical before choosing to refinance.
First, know what the rate on your current mortgage is, and then check Freddie Mac's Primary Mortgage Market Survey to see how current rates measure up. If market rates are lower than the rate on your existing mortgage — ideally by at least half a percent — then refinancing may make sense financially.
Changes in financial situation
Your financial situation should factor in, too. If your income has dropped, for example, refinancing into a new 30-year loan can help you reduce your monthly payment.
If, on the other hand, you got a raise and can now afford a larger payment, you may want to do the opposite — refinancing into a shorter-term loan to pay off your balance quicker. This would also reduce your long-term interest costs.
Goals for refinancing
Having a clear picture of your mortgage goals will help you make the right choice for your household. Do you want to pay off your mortgage as quickly as possible and with the least interest? Or is minimizing your monthly payment and stretching your budget most important?
You can also factor in other financial goals. If you want to free up cash for other investments, for instance, refinancing may be able to help you do that.
Process of a rate-and-term refinance
The rate-and-term refinance process isn't very different from getting an initial mortgage. You'll choose a lender, apply for your loan, and then close on the loan and pay your closing costs. Here's how the exact process breaks down.
Steps to apply for refinancing
To apply for a refinance, you'll need to first determine which loan program you want to use. There are conventional loans, as well as government-backed options like FHA, USDA, and VA loans. If you're not sure which is right for your budget and credit score, talk to a loan officer.
After that, you should:
- Gather your documents. You'll need these when filling out your applications.
- Choose which lenders you may want to work with. Consider a mix of banks, credit unions, and online lenders.
- Apply for preapproval. Lenders will then give you a loan estimate you can use to compare offers.
- Fill out the full application. Complete your chosen lender's application and submit all required documentation.
- Lock your interest rate. This protects you from rate increases while you close on your loan.
- Get your home appraised. The lender will send out an appraiser to determine the value of your home.
- Close on your loan. This is when you'll sign the final documents and pay your closing costs.
Choosing the right lender
As with any mortgage, picking the right lender is critical. Not only will it impact what loan programs you have access to, but it can influence your rate and fees heavily, too.
Always get quotes from at least a few different mortgage lenders. Then, use the loan estimates they give you to compare rates, fees, and other details. You can also negotiate with lenders using these forms.
Closing on the new mortgage
Finally, you'll close on your new loan. Once you're done, the new loan will be used to pay off the old one, officially replacing it. You'll start making payments on the new mortgage the following month.
Keep in mind that refinances require closing costs just like traditional mortgages. You can typically expect to pay anywhere from 2% to 6% of the mortgage amount. Some lenders will let you finance these costs — meaning include them in your loan balance — but this results in a higher payment and more interest costs in the long run.
Considerations and drawbacks
Rate-and-term refinances can sometimes be a smart move, but they aren't perfect. Here's what you'll want to consider before moving forward with one.
Closing costs and fees
Closing costs are one of the biggest drawbacks of rate-and-term refinancing, and according to ClosingCorp, the average refinance closing costs in the US come to $5,779. For many homeowners, that can be a significant sum to produce.
While you may be able to roll these into your loan balance, it could increase your monthly payment — and cost you a lot more in interest in the long run.
Break-even point analysis
Calculating your break-even point can help you determine if a rate-and-term refinance is financially worth it. Just take the total closing costs for your refinance and divide them by the monthly savings the refinance would offer you. This gives you the break-even point — the month in which the refinance saves you more than it cost to take out. If you know you'll stay in the home long enough to reach that month, refinancing may be smart.
Impact on total interest paid over the life of the loan
You should also think about the lifetime savings a refinance could net you — particularly if you plan to stay in the home for the long haul.
Once you've received a few quotes, use a mortgage calculator to determine how much the refinance could save you over the full term of your loan. Sometimes, even a small drop in your interest rate can equate to tens or even hundreds of thousands saved.
FAQs
A rate-and-term refinance replaces your existing mortgage with a new one — one with a new interest rate, term, or both.
Rate-and-term refinances can reduce your monthly payments in two ways: First, by lowering your interest rate. This reduces your total interest costs each month, thereby lowering your monthly payment. Additionally, refinancing into a longer-term loan — which spreads your balance across more months — can also reduce your payment.
To qualify for a rate-and-term refinance, you'll need a good credit score, a certain level of home equity, stable income, and a low debt-to-income ratio. Lenders may also require specific documentation to process your application.
Consider refinancing when interest rates drop significantly below your current rate, your financial situation changes, or you want to adjust your loan term to either pay off your mortgage quicker or reduce monthly payments.
Potential drawbacks include closing costs, fees, and possibly extending the time it takes to pay off your home, which could result in paying more interest over the life of the loan.
