What Is A Rate And Term Refinance?
January 29, 2024 8-minute read
Author: Victoria Araj
Have you been wanting to take advantage of lower rates since you originally obtained your loan? If so, you may want to consider a rate and term refinance. This can allow you to pay less in interest or reduce your monthly payment.
Let’s take a look at what a rate and term refinance is and how it works. We’ll also show you some of the benefits of a refinance and how you can apply for a refinance for your home.
Rate And Term Refinance: The Basics
A rate and term refinance, sometimes called a rate and term option or Rato mortgage, is a type of refinancing that allows you to change the terms of your current loan and replace them with terms that are more favorable for you. You get a new loan, pay off your old mortgage and then make payments toward your new loan when you refinance. 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 payment. Some lenders refer to rate and term refinances as regular refinances.
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Reasons To Do A Rate And Term Refinance
Homeowners can take advantage of a number of benefits when they refinance. These include:
Lowering Your Rate
Are current interest rates lower than when you 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. Taking an interest rate that’s even a fraction of a percentage lower can help you save thousands of dollars over the course of your loan. This means that it’s often beneficial to refinance whenever you can get a lower interest rate than what you’re paying currently.
Reducing Your Payment
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 help you avoid foreclosure if you’re having trouble making your payments. Keep in mind that refinancing to reduce your payment means you’ll end up paying more in interest over time.
Changing 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 less in interest over the course of your loan. This can mean thousands (or even tens 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.
Changing 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 refinance a Federal Housing Administration (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 refinance your mortgage loan’s rate or term:
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. You may want to consider a VA Streamline Refinance (if you got a Department of Veterans Affairs (VA) loan) or FHA Streamline Refinance if your credit score is lower. These loan options allow you to refinance without a credit check.
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 and can be calculated by dividing your monthly minimum debt payments by your monthly earnings, before tax. Aim for a DTI of 50% or lower before you apply.
You’ll need to account for closing costs when you refinance. Closing costs for a refinance usually equal around 2% – 6% of the principal balance on your loan. 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 a first mortgage loan. You’ll submit an application to your lender along with some financial documentation. Your lender will then schedule underwriting, an appraisal and your closing meeting.
Do you think a rate and term refinance might be right for you? Here’s more information on what you can expect to do when you get your new loan.
Apply For A 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. Submit an application to your 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 more 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 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.
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 of your 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.
Get An Appraisal
Your lender will also schedule an 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 your appraisal. Make sure your property is in the best condition possible before the appraiser arrives.
Opting for a certain type of refinance like a VA or FHA Streamline? You may be able to skip the appraisal requirement.
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 loan. 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.
Be sure your monthly payment is lower than your current payment if you want to refinance to a longer term. Taking 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 things match up.
Close On Your Loan
It’s time to close on your loan once your lender finishes underwriting. After you’ve 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 for 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 when you take a cash-out refinance.
For example, let’s say you owe $100,000 on your current mortgage loan and you’ve paid off $50,000. 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 repairs 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.
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.
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 refinance. 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 refinances.
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. Rate and term refinances can help you pay less for your loan over time, lower your monthly payments or pay off your loan faster. Rate and term refinances are different from cash-out refinances; the latter allows you to take cash from your home equity in exchange for a higher principal. You must meet your lender’s income, debt and credit score requirements before you qualify for a refinance.
Applying for a refinance is similar to applying for your initial home loan. You’ll first submit an application to your lender with your financial documents. You’ll have the opportunity to lock your interest rate after you apply. Lastly, your lender will schedule your underwriting, appraisal and closing processes.
If you’re ready to apply for a rate and term refinance, start your application online today with Rocket Mortgage.
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