Ever feel like your mortgage payment is a little too high, or maybe you’re just curious if you can get a better deal on your home loan? You’re not alone! Many homeowners consider refinancing their mortgage at some point. One of the most common reasons to do this is through a “rate-and-term refinance.” It sounds a bit fancy, but it’s actually a straightforward way to potentially save money and improve your financial situation.
What Exactly Is a Rate-and-Term Refinance?
Think of refinancing as getting a whole new mortgage to replace your old one. When you do a rate-and-term refinance, you’re essentially keeping your loan amount the same (or very close to it) but changing two key things: the interest rate and the loan term.
- Rate: This is the interest rate on your mortgage. If market interest rates have dropped since you got your original loan, you might be able to get a lower rate. Lowering your rate can directly lower your monthly payment.
- Term: This is the length of time you have to repay your mortgage, commonly 15 or 30 years. You might choose to extend your term to lower your monthly payments or shorten it to pay off your home faster.
It’s important to distinguish this from a “cash-out refinance,” where you borrow more than you owe on your current mortgage and take the difference in cash. With a rate-and-term refinance, you’re not taking out extra cash; you’re just optimizing the terms of your existing debt.
How Does a Rate-and-Term Refinance Work?
The process is quite similar to when you first applied for your mortgage.
- Shop Around: Just like when you bought your home, you’ll want to get quotes from multiple lenders. Different lenders offer different rates and fees, so comparing is key.
- Application & Approval: You’ll fill out a new loan application, and the lender will review your credit history, income, and assets. They’ll also order a new appraisal of your home to determine its current market value.
- Closing: If approved, you’ll go through a closing process, similar to your original mortgage closing. You’ll sign new loan documents, and the new loan will pay off your old one.
Keep in mind that refinancing involves costs, often called closing costs. These can include appraisal fees, title insurance, recording fees, and lender origination fees. You’ll want to make sure the savings from the refinance outweigh these costs.
Why Would Someone Choose a Rate-and-Term Refinance?
People opt for this type of refinance for several good reasons:
- Lower Monthly Payments: If interest rates have fallen, you can refinance to a lower rate, which reduces your monthly principal and interest payment. This frees up cash for other expenses or savings goals.
- Switching Loan Types: Maybe you have an adjustable-rate mortgage (ARM) and want the stability of a fixed-rate mortgage. Or perhaps you want to switch from a 30-year term to a 15-year term to pay off your home sooner.
- Improving Equity: By shortening your loan term (e.g., from 30 years to 15 years), you’ll pay more towards the principal each month, building equity faster and saving a significant amount on interest over time.
Real-World Example
Let’s say Sarah has a 30-year mortgage for $300,000 with an interest rate of 5%. Her monthly principal and interest payment is about $1,610. After five years, she decides to refinance because interest rates have dropped to 4%.
- Original Loan: $300,000 at 5% for 30 years. Monthly P&I: $1,610.
- Refinanced Loan: $280,000 (original balance minus payments made) at 4% for 30 years. Monthly P&I: $1,337.
In this scenario, Sarah could lower her monthly payment by about $273. If she continues with the 30-year term, she’ll also pay less interest over the life of the loan. Alternatively, she could refinance into a 15-year loan at 4% to pay off her mortgage much faster, although her monthly payment might be slightly higher than her original 5% payment.
Who Does a Rate-and-Term Refinance Affect?
- Homeowners with Good Credit: Lenders want to see a solid credit history and stable income to approve a refinance.
- Homeowners with Equity: You generally need a certain amount of equity in your home to qualify for a refinance.
- Homeowners in Falling Interest Rate Environments: This is when a rate-and-term refinance is most attractive.
Tips for a Successful Rate-and-Term Refinance
- Know Your Goal: Are you trying to lower your monthly payment or pay off your loan faster? Your goal will determine whether you aim for a lower rate, a shorter term, or both.
- Check Your Credit Score: A higher credit score usually means a better interest rate. Work on improving your score if needed before applying.
- Calculate the Break-Even Point: Estimate your closing costs and divide them by your estimated monthly savings. This tells you how many months it will take for the savings to cover the costs. If you plan to move before reaching that point, it might not be worth it.
- Don’t Ignore Fees: Lenders may offer a slightly higher interest rate in exchange for a lower or no origination fee, or vice versa. Understand the trade-offs.
Common Misconceptions
- “Refinancing always lowers my payment.” Not necessarily. If you shorten your loan term significantly, your monthly payment could actually increase, even with a lower interest rate.
- “Refinancing is free money.” Refinancing involves closing costs, which can add up. You need to ensure the long-term benefits justify these upfront expenses.
By understanding how a rate-and-term refinance works, you can decide if it’s the right move to help you achieve your financial goals related to your homeownership.
Sources:
Mortgage Refinance
Fixed-Rate Mortgage
Adjustable-Rate Mortgage (ARM)
Loan Term
Mortgage Points