Rate and term refinance, explained

If you’ve ever financed a home, you probably know that mortgage rates aren’t static. Even if you found the best rate possible at the time of buying, 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 obtain a new mortgage with new terms. There are a few reasons you might want to explore this type of refinance, from lowering your monthly mortgage payments to paying off your mortgage a little bit earlier. Let’s take a closer look at how rate and term refinances work, when a rate and term refinance may be something to consider and how it may differ from other types of refinancing.

How rate and term refinances work

If you’re wondering “What is a rate and term refinance?” or how it works, we’re here to explain the basics. 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 credit score between fair and excellent 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. Lenders generally agree on a maximum DTI of 43% and prefer a DTI of 36% or less.
• 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): Having a loan-to-value ratio of 95% or less may be required by some lenders. 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 percentage into your monthly mortgage payments.

Rate and term refinance example

Let’s say your original loan was for $200,000 with an interest rate of 7% and a 30-year term. For the sake of this example, we’ll say monthly payments are around $1,500. If interest rates have gone down since you got the original loan, you may be interested in refinancing. If you apply and qualify for a new loan with an interest rate of 5% and the same 30-year terms, you could reduce your monthly payments to around $1,337. Alternatively, if funds allow, you could opt for a 15-year mortgage term with a higher monthly payment in the spirit of paying off the loan sooner.

Benefits of rate and term refinance

A rate and term refinance may be beneficial to borrowers in several ways:

• 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 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:

• 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.
• 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 best for you.
• Get your documents in order: It may be a good idea to gather required documents ahead of the preapproval 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.
• 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.
• Submit your application: The next step is generally to submit your application and submit all those documents you’ve gathered in advance. While applying for a mortgage with multiple lenders could possibly give you some edge to negotiate after comparing rates, it may also have an impact on your credit score.
• 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.
• 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 and make sure you understand and approve the terms before you sign.
• 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 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

• Allows borrowers to take equity out of their home in exchange for cash.
• 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.
• With this type of refinance, the refinanced mortgage is higher than the original.

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.

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 off the loan faster. Either option could increase your financial flexibility and save you money on interest, leaving you with funds to cover other exciting life expenses.

Rate and term refinance FAQs

1. How soon can you do a rate and term refinance?

There’s no waiting period for a rate and term refinance, but you may want to wait until you have 20% or more equity in your home built up. This helps with your loan-to-value ratio (LTV) and tells lenders you’re financially responsible enough to take on a new loan.

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 exact 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.