Rate-and-Term Refinance

What Is a Rate-and-Term Refinance?

A rate-and-term refinance changes the interest rate, the term — or both the rate and the term — of an existing mortgage without advancing any new money. It is also known as a “no cash-out refinance.”

This differs from a cash-out refinance, in which new money is advanced on the loan and the borrower receives cash at the closing in addition to their new loan. Rate-and-term refinances often carry lower interest rates than cash-out refinances.

Understanding Rate-and-Term Refinance

Rate-and-term refinancing activity is driven primarily by a drop in market interest rates in order to lower monthly mortgage payments. This can be contrasted with cash-out refinance activity that is driven by increasing home values by homeowners seeking to tap into their home equity.

The potential benefits of rate-and-term refinancing include securing a lower interest rate and a more favorable term on the mortgage; the principal balance remains the same. Such refinancing could lower your monthly payments or potentially set a new schedule to pay off the mortgage more quickly. There are several ways to exercise a rate-and-term option.

Because there are advantages and disadvantages associated with both rate-and-term and cash-out refinancing, you must weigh the pros and cons of each before making any final decisions.

Requirements for Rate-and-Term Refinancing

For rate-and-term refinancing to work, lower interest rates must be available to the borrower. There are two main reasons why this might not be the case. The first is that interest rates in the overall economy can go up during the application process, making them no longer available. This is one of the many factors influencing interest rates over which borrowers have no control.

However, you do have some control over your consumer credit. If you have defaulted on credit cards or mortgage payments, you will probably face higher interest rates. These personal factors are usually more important than market interest rates. On the other hand, if your credit has improved substantially, you may be able to refinance at a lower interest rate.

Cash-out refinancing increases the principal owed on your mortgage.

Rate-and-Term Refinancing vs. Other Options

Cash-out refinancing takes equity from your home for you to use. It works best when the overall value of the property has increased because of rising real estate values. However, cash-out refinancing can also be done if you are well along in the mortgage and have paid in a significant part of its equity. A cash-out refinancing increases the principal owed on your mortgage.

This form of refinancing might call for a re-appraisal of the home to gauge its new value. You might seek such refinancing to gain access to capital from the value of the house, money you otherwise might not see until the home was sold. A converse option called “cash-in refinancing” involves putting more money toward the settlement of the mortgage to reduce any remaining principal.

When considering any of these options, it is important to calculate all the implications carefully and see how they compare to keeping your current mortgage.

Examples of Rate-and-Term Refinancing

Say you have been paying off a 30-year mortgage for 10 years and interest rates suddenly drop; you might want to take advantage of the new rates. One option would be to refinance the balance left on the original mortgage at that lower rate for a new 30-year full term. The new loan would have lower monthly payments, but it would be like starting over at a lower rate. It would add 10 years to the total time to pay off the mortgage. There were 10 years spent paying the first mortgage, and there would be another 30 years for the new one, which would equal 40 years in total. Between the lower interest rates and the longer term, monthly payments would be much lower.

You could also use the rate-and-term refinancing option to pay the new interest rate and negotiate a 15-year mortgage. Your monthly payments would be twice as high as for a 30-year term, all other things being equal. However, because interest rates fell, your monthly payments may end up being lower than they were for the remaining 20 years of the original mortgage.

It’s more likely, though, that your monthly payments would still be higher because of the shorter term. The main advantage is that you would save five years of payments. There were 10 years spent paying the original mortgage, and there would be 15 years for the new one, which would equal 25 years in total.

Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).