What Is a Rate and Term Refinance?

Mortgage refinancing involves replacing an existing home loan with a new one. This process allows homeowners to adjust the terms of their mortgage to better suit their current financial situation. While various refinancing options exist, a “rate and term refinance” is a specific type designed to modify key aspects of the loan without extracting cash from the home’s equity. It focuses on enhancing the loan’s structure for potential long-term savings or more manageable payments.

Defining Rate and Term Refinance

A rate and term refinance primarily changes the interest rate, loan term, or both on an existing mortgage. This involves securing a new loan to pay off the current one, establishing new repayment conditions. The aim is to obtain more favorable terms without extracting cash from home equity. The new loan amount typically remains similar to the original, though it can increase if closing costs are rolled in.

A “rate” change means securing a lower interest rate than the original mortgage, which can reduce monthly payments and the total interest paid over the loan’s life. For instance, if prevailing interest rates have dropped since the initial loan origination, a homeowner might refinance to capture these lower rates. Alternatively, a “term” change involves adjusting the length of the repayment period. This could mean shortening a 30-year loan to a 15-year loan to pay it off faster and save on total interest, or extending a 15-year loan to a 30-year loan to lower monthly payments.

Distinguishing from a Cash-Out Refinance

A rate and term refinance differs from a cash-out refinance in its objective. With a rate and term refinance, the new loan amount is typically similar to the existing mortgage balance, as no additional funds are provided to the borrower. This type aims to improve the loan’s structure without increasing the total debt owed beyond the original principal.

In contrast, a cash-out refinance involves taking out a new mortgage for a larger amount than the existing loan balance. The difference between the new, larger loan amount and the payoff of the old mortgage is then paid directly to the borrower in cash. This cash is derived from the homeowner’s equity in the property. While both types replace the old mortgage with a new one, the key distinction is whether the borrower receives cash from their home equity (cash-out) or simply modifies the loan’s rate and term without receiving funds (rate and term).

Common Scenarios for Rate and Term Refinance

Homeowners often consider a rate and term refinance when market interest rates have declined since they obtained their mortgage. Securing a lower interest rate can reduce monthly payments, making the mortgage more affordable and potentially saving thousands of dollars in interest over the loan’s duration.

Another frequent scenario involves homeowners wanting to switch their loan type, such as moving from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. An ARM’s interest rate can fluctuate, leading to unpredictable monthly payments, while a fixed-rate mortgage offers stability with consistent payments throughout its term. Homeowners might also seek to change their loan term, perhaps shortening a 30-year loan to a 15-year one to accelerate payoff and build equity faster, or extending a shorter loan to 30 years to lower monthly payments for increased financial flexibility.

The Refinance Process

Embarking on a rate and term refinance involves several procedural steps, similar to obtaining an initial mortgage. The process typically begins with researching and comparing offers from various lenders to find the most competitive rates and terms. Homeowners should obtain a Loan Estimate from each prospective lender, which details estimated terms, payments, and closing costs, allowing for direct comparison.

Once a lender is chosen, the homeowner submits a formal application. The process then typically involves:
Submitting necessary financial documentation, such as pay stubs, tax returns, and bank statements, to verify income and assets.
An appraisal of the home to determine its current market value.
Underwriting, where the lender evaluates the borrower’s creditworthiness, income, and the property’s value to approve the new loan.
Closing, if approved, where all loan documents are signed.
Paying closing costs, typically 2% to 6% of the loan amount, or rolling them into the new loan.