What is rate and term refinancing?
Wishing you could make life a little easier by changing up your mortgage loan? A rate and term refinance is one option if you’re looking to score a lower monthly payment or cut down the amount of interest you’ll have to pay in the long run. It’s all about making your mortgage work for you, and the rate and term refi route lets you update your mortgage rate or loan length to something more your style. Your brand-new loan will get used to pay off your existing one, and from there, you’ll start chipping away at that new mortgage.
Reasons to do a rate and term refinance
Wondering why you’d go with a rate and term refinance? Let’s talk loan types. If you’ve got an adjustable-rate mortgage but you’re craving more predictability, a rate and term refinance can help you switch to a fixed-rate mortgage. Making that swap means your interest rate and monthly payments will stay the same—but let’s look at some of some the other top reasons to take advantage of this type of refinancing:
The benefits of rate & term refinancing
Lower your interest rate
If interest rates have dropped since you got the keys to your new home, a rate and term refinance could help you cash in on some serious savings. Locking in a new lower rate can help you save money over the life of your loan, which can be an attractive option depending on your situation.
Reduce your monthly payment
If you’ve got lower monthly mortgage payments on your mind, stretching out your repayment term can help put some money back in your pocket in the short term. But just remember, the longer you spend paying off your loan, the more you’ll shell out in interest over time.
Modify your loan term
One rate and term refinance example could involve swapping your 30-year mortgage for a 15-year one. A shorter term means owning your home debt-free even sooner and could save you a bundle on interest over time. However, although you’ll build equity faster, you’ll have to deal with higher monthly payments.
Rate and term refinance requirements
So, what are the rules for rate and term refinancing? Here are a couple of things you’re going to want to know.
Credit score
To approve your refi, most lenders will want a credit score of 620 or higher. But, depending on the type of loan you have, that magic number could look a little different. An FHA rate and term refinance, for example, could be on the table with a score between 500 and 580 or even without a credit history at all. So, it’s worth discussing your options with a financial advisor.
Home equity
First, a quick refresher—home equity is the part of your place that you actually own, and you get that number by taking your home’s value and subtracting the amount you still owe on your loan.
Let’s say your home is valued at $200,000. If your mortgage balance is $140,000, then your equity would be $60,000.
What does that mean for refinancing? In general, most lenders want to work with applicants who have at least 20% equity. You can still complete a rate & term refinance if you have less than this, but keep in mind you may have mortgage insurance depending on the loan program you choose.
Pro Tip
Wondering how much equity you can borrow? Try our HELOC Calculator.
Debt-to-income ratio (DTI)
Your DTI shows how much of your income goes toward your debts each month. When it comes to rate and term refinances, most lenders want that number to be 43% or lower. If it’s under 36%, that can put you in a better position to lock in more favorable rates.
Closing costs
Heads up: Your new loan will likely come with closing costs. These fees will include things like your loan origination fee—that’s the cost of setting up your new loan—along with appraisal, title insurance and lender fees. Closing costs can vary a lot, but you can usually count on them being 2% to 6% of your new loan.
Rate and term vs. cash-out refinance
Rate and term isn’t the only refinancing option on the block. A cash-out refinance is another go-to for homeowners, and one that might be a good fit for your finances.
| Rate & Term Refinance | Cash-Out Refinance | |
|---|---|---|
| Purpose | Primarily to adjust the interest rate and loan term. | To turn home equity into cash for various uses. |
| Changes to Mortgage | Adjusts either the interest rate, the loan term or both. No increase in loan principal. | Replaces the current mortgage with a new one, based on home equity, and provides the difference in cash. |
| Financial Impact | Can lower monthly payments, reduce interest rates or shorten the loan term. | Provides cash for use (e.g., home improvements, debt payment), potentially with new loan terms and possibly a different interest rate or loan duration. |
| Loan Amount | Remains the same or decreases if principal is paid down. | Increases due to the additional cash taken out against the equity. |
| Use of Funds | No cash out. The focus is on bettering the terms of the existing loan. | Cash received can be used for any purpose, such as renovations, debt consolidation, etc. |
| Risk Level | Lower risk as it often aims to improve financial stability through better terms. | Higher risk due to increased loan amount and the potential for higher debt obligations. |
Now that you’ve got the basics down, let’s take a deeper dive into how they compare.
How are they similar?
For starters, both replace the mortgage you have with a new one that comes with loan terms you’ll like better. The getting-started process is also pretty much the same. You’ll need to fill out an application, have your credit checked, get your home appraised and pay your closing costs.
Can you refinance your mortgage to consolidate debt?
Yes, you can refinance your mortgage to consolidate debt. This method involves taking out a new mortgage and using the extra funds to pay off other debts, such as credit card balances, student loans or medical bills.
This is often referred to as a debt consolidation refinance, which is similar to a cash-out refinance but with a few key differences:
- Targeted debt payoff
Specific liabilities, as identified in your credit report, are marked to be paid off directly at closing using the cash proceeds from the new mortgage. This strategic payoff helps in reducing your debt-to-income ratio (DTI). - Improved qualification chances
By lowering your DTI, this refinancing approach can help you qualify for a new loan—something you might not have been able to do before. A lower DTI not only reduces perceived risk from the lender’s perspective but might also qualify you for a loan program with more favorable terms and a lower interest rate. - Direct payment to creditors
The cash proceeds from the debt consolidation refinance are sent directly by the lender to your creditors, not to you. This ensures that debts are paid off efficiently and reduces the risk of funds being diverted to other uses. - Disbursement of remaining funds
If there are any remaining funds after your debts have been paid, these will be provided to you. This can offer some additional financial breathing room or be used for other important expenses.
This type of refinancing can be a smart strategy to manage and reduce your overall debt burden, streamline your finances and potentially improve your financial health over the long term.
How to get a rate and term refinance
Ready for the scoop on how to get your refinance moving? There are a few steps you’ll have to get through before you can take advantage of those brand-new terms.
1. Apply for the mortgage refinance
Just like your first go-around, you’ll need an application under your belt. Your lender will need information on your income, credit and the details of your current mortgage, so have that close at hand.
2. Get your new rate
Once your application gets the OK, you’ll have the chance to lock in your new interest rate. This is a big deal because it guarantees the rate you’ll get for your refinance.
3. Get your home appraisal
Some lenders want an appraisal to double-check the market value of your home, so be prepared to build that into your schedule. They want to make sure that the home you’re looking to refinance is still worth what you say it is. This means they’ll take a close look at your home to make sure it’s in good shape. They’ll also check out what other homes in your neighborhood have sold for to see if they match up.
4. Review closing disclosures
You’re almost at the finish line, but before you close on your loan, you’ll need to go over your closing disclosures. These spell out your interest rates, monthly payments and closing costs. Give them a good read, and if something doesn’t add up, don’t hesitate to ask your lender.
5. Close on your loan
The big finale: signing on the dotted line for your new loan and taking care of the closing costs.
