What Is A Rate-And-Term Refinance?

Are interest rates lower now than when you originally obtained your mortgage loan? If so, you might consider a rate-and-term refinance. With this refinance option, you have an opportunity to adjust your loan terms. By changing your mortgage rate or term length, you could pay less in interest over the life of the loan or reduce the amount of your monthly payment.

Depending on your specific situation, like your reason for refinancing and your qualifying factors, a rate-and-term refinance could be a great option for you.

Rate-And-Term Refinance: The Basics

A rate-and-term refinance, sometimes called a rate-and-term option or a Rato mortgage, is a type of refinance that allows you to change the terms of your current loan and replace them with terms that are more favorable for you.

When you refinance, you get a new loan, pay off your old mortgage and start making payments toward your new mortgage. A rate-and-term refinance can give you more or less time to pay off your loan, a lower interest rate or a different monthly mortgage payment. Some lenders refer to rate-and-term refinances as regular refinances.

Reasons To Do A Rate-And-Term Refinance

Homeowners can take advantage of a number of benefits when they refinance. Let’s take a look at some of the most common reasons homeowners choose to refinance their mortgage.

Lower Your Interest Rate

If current interest rates are lower than when you first got your loan, you may be able to get a lower rate. You might also qualify for a lower interest rate if you have a better credit score or less debt now than when you got your original mortgage.

Opting for a mortgage with an interest rate that’s even a fraction of a percentage lower can help you save thousands of dollars over the course of the loan term. This means that it’s often beneficial to refinance when you can get a lower interest rate than what you’re currently paying.

Reduce Your Monthly Mortgage Payment

You might choose a rate-and-term refi if you’re looking for lower monthly payments. Your monthly payment goes down when you refinance a mortgage loan to a longer term. This is because you give yourself more time to pay off your loan and make more overall payments.

Refinancing to a longer term and reducing your monthly payment can also help you avoid foreclosure if you’re having trouble making your payments. Keep in mind that refinancing to reduce your mortgage payment likely means you’ll end up paying more in interest over time.

Modify Your Term Length

You can also refinance your mortgage loan to a shorter term, such as refinancing to a 15-year mortgage from a 30-year mortgage. Doing so increases your monthly payment, but you end up paying much less in interest over the course of your loan. This can mean tens of thousands (or even hundreds of thousands) of dollars saved by the time your loan matures.

Are you now earning more in income than when you got your loan? Refinancing to a shorter term can help you own your home sooner.

Change Your Loan Type

With a rate-and-term refinance, you might also be able to change the type of loan that you have. For example, you may be able to refinance an adjustable-rate mortgage (ARM) into a fixed-rate mortgage or switch from an FHA loan to a conventional mortgage.

Rate-And-Term Refinance Requirements

Just like when you applied for your initial loan, you’ll need to meet your lender’s standards before you qualify for a refinance.

Let’s take a look at some of the mortgage refinancing requirements to adjust your mortgage interest rate or term.

Credit Score

Refinances have minimum credit requirements that vary by loan type. Most lenders require a credit score of at least 620 to qualify for a refinance for a conventional loan. Do you have an FHA loan? These types of loans have a median minimum qualifying score of 500, though most lenders set their own requirements. For example, Rocket Mortgage® requires a minimum credit score of 580 for FHA loans.

If your credit score is lower and you have a VA or FHA loan, you may want to consider a VA Streamline refinance or FHA Streamline refinance, respectively. These loan options often allow you to refinance without a credit check.

Home Equity

Your home equity is the percentage of the loan principal you’ve paid off. It’s a good idea to wait to refinance until you have at least 20% equity in your home. It’s possible to refinance with a lower equity percentage, but you won’t have access to the most favorable interest rates.

Debt-To-Income Ratio (DTI)

Lenders also consider your DTI when they look at your refinance application. Your DTI compares your recurring monthly debt payments to the amount of money you have coming in. It can be calculated by dividing your monthly minimum debt payments by your monthly earnings before taxes. Aim for a DTI of 50% or lower before you apply to refinance.

Closing Costs

You’ll need to account for closing costs when you refinance your mortgage. Closing costs for a refinance usually equal around 2% – 6% of the principal balance on your loan. If you can’t cover closing costs upfront when you refinance, you may be able to roll them into your new loan with a no-closing-cost refinance if you have enough equity.

How To Get A Rate-And-Term Refinance

Applying for a refinance is similar to applying for your first mortgage loan. You’ll submit an application to your lender along with some financial documentation. Your mortgage lender will then schedule underwriting, a home appraisal and your closing date.

Do you think a rate-and-term refinance might be right for you? Here’s more information on what you can expect from the process.

1. Apply For The Mortgage Refinance

The first step in any refinance is to apply with your lender of choice. Research lenders in your area and consider current mortgage interest rates. You also have the option to refinance with your current mortgage lender. Submit an application to your chosen lender and specify that you want to refinance your rate or term.

Your lender will ask you for a few important financial documents when you apply for your refinance, including your:

• Two most recent pay stubs
• Two most recent bank statements
• Two most recent W-2s

You may need to provide additional documentation if you’re self-employed. Have your paperwork in order before you apply for a faster refinance.

Your lender will begin the underwriting process once you submit your refinance application. Your lender verifies your income during underwriting and makes sure that you qualify for a refinance. Respond to all lender inquiries during this time to help keep your refinance on track.

2. Lock In Your New Rate

Your lender will give you a document called a Loan Estimate after you apply for your refinance. Your Loan Estimate gives you an estimate of the fees and costs associated with your new loan. Hang onto this document – you’ll need to compare it to your Closing Disclosure later on.

You’ll also have the option to lock in your mortgage rate. Interest rates change on a daily basis. When you lock in your rate, you protect yourself from interest rate changes that occur between your refinance application to closing. Most lenders allow you to lock your rate for 30 – 60 days.

Want to extend your rate lock? You may need to pay an additional fee.

3. Get An Appraisal

Your lender will also schedule a home appraisal to determine your home’s value. Appraisals are important because they assure your lender that they aren’t giving you more money than your home is worth. You’re free to attend the appraisal when you refinance because you already own the home. Make sure your property is in the best condition possible before the appraiser arrives.

If you’re opting for a certain type of refinance like a VA or FHA Streamline, you may be able to skip the appraisal requirement.

4. Review Your Closing Disclosure

Your lender will issue you a document called a Closing Disclosure before you attend your closing. Your Closing Disclosure contains important details about your new mortgage. You'll find your principal balance, interest rate and monthly payment. Read through this document carefully and make sure the terms match up with the refinance you want.

If you’re refinancing to a longer loan term, make sure your monthly payment is lower than your current payment. Are you getting a lower interest rate? Your monthly payment should be lower as well. Compare your new Closing Disclosure with the terms of your current loan and make sure all of the information is correct.

5. Close On Your New Loan

Once your lender finishes underwriting, it’s time to close on your loan. After you read your Closing Disclosure and make sure the terms are correct, contact your lender and acknowledge that you’ve received the Closing Disclosure. Your lender will then schedule your closing meeting.

At closing, you’ll ask any last-minute questions you have about your new loan and sign all the necessary paperwork. Bring along your photo ID, your Closing Disclosure and a proof of transfer or a cashier’s check to cover your closing costs. Your lender will appoint a neutral third party to conduct the closing and finalize your refinance.

Rate-And-Term Vs. Cash-Out Refinance

You don’t need to change your rate or term when you refinance – you can also take money out of your home equity with a cash-out refinance. You accept a higher principal loan balance and take the difference out in cash with a cash-out refi.

Let’s consider an example. Say you owe $100,000 on your existing mortgage and you’ve paid off $200,000. You want to do $20,000 worth of repairs on your home, so you take a cash-out refinance. At closing, you sign on a new loan worth $120,000 and your lender gives you $20,000. Many homeowners use this money to consolidate debt, fund home improvements or boost their retirement savings.

Let’s take a look at some of the similarities and differences between rate-and-term refinances and cash-out refinances.

Similarities

Some of the similarities between rate-and-term refinances and cash-out refinances include:

• You take out a new loan. Both cash-out refinances and rate-and-term refinances involve paying off your current mortgage loan as well as taking on a new loan with different terms.
• You can work with a new lender. Whether you take a rate-and-term refinance or a cash-out refinance, you have the option of working with a new lender. You don’t need to refinance with the lender that gave you your current loan.
• You can change your rate or term. In addition to adjusting your principal, it’s possible to change both your interest rate and loan term when you take a cash-out refinance. This is in addition to taking cash out of your equity.

Differences

There are also a few important differences between rate-and-term refinances and cash-out refinances.

• Your principal balance might not change. No matter how you change your term or interest rate with a rate-and-term refinance, your principal balance could remain the same if you didn’t roll your closing costs into your loan. When you get a cash-out refinance, you accept a higher principal balance and take the remainder out in cash.
• You take cash after closing. You’ll receive cash a few days after closing when you get a cash-out You don’t receive any cash from your lender when you get a rate-and-term refinance.
• There are home equity requirements. You must have a minimum amount of equity in your home before you qualify for a cash-out refinance. For example, you may want to take $50,000 out of your home equity and have at least $60,000 in equity to draw from. This requirement doesn’t apply to rate-and-term

Rate-and-term refinances and cash-out refinances are for different types of borrowers. If you’re unsatisfied with your current monthly payment or interest rate, a rate-and-term refinance – or even a no cash-out refinance – might be right for you. Do you want to consolidate debt or cover a major expense? You might want to consider a cash-out refinance.

The Bottom Line

A rate-and-term refinance can allow you to replace your current home loan with a new one. You can change your mortgage term or your interest rate with a rate-and-term refinance. With this refinance option, you can pay less in interest over time, lower your monthly payments or pay off your loan faster.

If you’re ready to apply for a rate-and-term refinance, start your application online today with Rocket Mortgage.