• A rate and term refinance is a form of mortgage refinancing where a current mortgage is replaced with a new mortgage, under a new interest rate and new loan duration, without converting any home equity into cash.
  • Depending on your financial profile and economic conditions, rate and term refinancing can be used to lower mortgage payments, reduce the total interest expense of the loan, and/or lock in a lower interest rate for the life of the loan.  
  • Refinancing comes with closing costs, so it’s important to consider how long it will take for your savings to offset the expense of refinancing. 

Are you interested in reducing your mortgage payment, saving money on interest expenses, or maybe paying off your home loan faster? A rate and term refinance could be the solution you’re looking for. 

This article will explain the ins and outs of rate and term refinancing to help you understand how it works and whether it’s the right financial move for you.  

What Is a Rate and Term Refinance?

Rate and term refinancing (also called a rate term refinance or simply rate term refi) is a form of mortgage refinancing, where you replace your current mortgage with a new mortgage loan, under new terms, but without taking cash out of your home equity.

This is often done to achieve one or more of these main goals:[1]

  • To reduce the interest rate. This could lower your mortgage payments and save you money in total interest expense over the life of the loan. If interest rates have come down since the origination of your current mortgage, or you have improved your credit score so that you now qualify for a lower rate than the one of your current mortgage, you may be able to secure a lower interest rate through refinancing. 
  • To adjust the loan term. Extending the loan term can reduce your monthly payments by spreading the remaining balance across more months (although this could result in a higher total interest expense over the life of the loan). Shortening the loan term can help you build home equity faster, pay off your home sooner, and reduce your total interest expenses, but it can also increase your monthly payments. 
  • To change from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. With an ARM, the interest rate adjusts at set intervals based on changing market conditions, which can result in more expensive mortgage payments over time, particularly if interest rates are trending up. With a fixed-rate mortgage, on the other hand, interest rates don’t change. Some borrowers choose an ARM when buying a home because ARMs offer lower introductory interest rates than fixed-rate mortgages. Then they refinance to a fixed-rate mortgage to lock in a fixed rate for the rest of the loan.
  • To lower the mortgage payment. If the interest rate is reduced or the loan term lengthened, your monthly mortgage payments can go down. Consult an online mortgage refinance calculator to see how your payments and total interest expense could change from a rate and term refi.     

Rate and Term Refinance vs. Cash-Out Refinance

With a rate and term refinance, you don’t walk away from the process with cash in your pocket. This makes rate and term refinancing different from cash-out refinancing, in which the goal is to convert some of your home equity into cash. This distinction is so important that a rate term refi is sometimes referred to as a no-cash-out refi. 

Rate and term refinancing is used by homeowners who want to lock in a better interest rate or change the length of their loan without increasing their mortgage balance. It’s a strategic move for those who plan to stay in their home long-term and want to maximize savings and/or increase financial stability.

Cash-out refinancing, on the other hand, is used by homeowners who have built up significant equity and want to access funds for large expenses, such as home improvements, consolidating high-interest debt, or financing other large purchases. This allows you to tap into your home’s value without taking out a separate loan. However, you’ll likely see a higher monthly payment and pay more in interest over time because the cash-out refi increases your mortgage balance. If you cannot secure a lower interest rate, you may want to explore other home equity lending options (like a home equity loan or home equity line of credit) rather than using a cash-out refi.  

Eligibility and Requirements for Rate Term Refinancing

Homeowners must qualify for rate and term refinancing based on the following criteria:

  • Credit scores. Your credit score is used to determine if you qualify for refinancing and what interest rate the lender can offer. While credit score requirements vary by lender, many lenders look for a score of at least 620 for refinancing. Higher credit scores may earn more favorable interest rates. 
  • Debt-to-income (DTI) ratios. DTI is a financial metric that compares your current debt obligations to your gross (pre-tax) income to see how much of your income must be allocated toward debt payments. Requirements vary by lender, but many lenders prefer to have a borrower’s monthly debt payments remain below 36% of their gross income.[2] However, it may be possible to qualify for a refinance with a higher DTI in some cases. 
  • Loan-to-value (LTV) ratios. LTV is the percentage of the home’s value that the lender will allow the homeowner to borrow. For example, if a lender’s LTV limit is 80%, they will loan up to 80% of the home’s value, and expect the homeowner to retain at least 20% in home equity. LTV can vary by lender and loan type.[3]

Documentation Required to Apply for a Rate Term Refi

In addition to the refinance application (which can typically be completed online), applicants typically need to submit to a credit check and provide the following documentation:

  • Proof of income. Pay stubs for the last 30 days and W-2 forms or tax returns for the last two years.
  • Property information. Most recent property tax bill, current homeowner’s insurance policy.
  • Proof of assets. Account statements for all active bank and investment accounts for the last two months.

How Much Does Rate and Term Refinancing Cost? 

A rate and term refi typically costs 2-5% of the loan amount, depending on factors such as your lender, your credit profile, and the location of your home. This expense is known as closing costs and includes individual expenses such as:

  • The loan origination fee. 
  • An appraisal fee.
  • A credit report fee.
  • Title search fees.

You can use an online refinance cost calculator to estimate your closing costs.  

How to Pay Refinance Closing Costs

There are multiple options for paying closing costs:

Pay for them out of pocket. If you have the funds available, you can simply pay the closing costs prior to closing your new loan.

Roll them into the loan. Many lenders will allow you to finance the closing costs by rolling them into the loan. Essentially, you’re adding the closing costs to your mortgage balance and paying them over time with your new mortgage payment. 

No-cost refinancing. Some lenders offer no-cost refinancing, in which they replace the closing costs with a higher interest rate. It is important to run the numbers to determine how much more you’ll be paying over the term of the loan with the higher interest rate.[4]

How to Calculate the Break-Even Point for a Refinance

The break-even point is the amount of time it takes for your monthly savings from the refinance to equal the cost of refinancing. You can calculate the break-even point by dividing the total refinance cost by the monthly savings. This will provide you with the number of months needed to break even on the refi. As long as you remain in that mortgage to the break-even point, you will come out financially ahead on the refi.  

For example, if refinancing costs $3,000, and it lowers your mortgage payment by $150 per month, it would take you 20 months to break even ($3000 / $150 = 20). So your break-even point would be 20 months, and you would need to keep your new mortgage for at least 20 months to make it worth the cost of refinancing. 

The Refinancing Process: Step-by-Step

Here is a simple five-step overview of rate and term refinancing.

Step 1: Assess Your Current Mortgage Situation

Review your current mortgage payment amount, loan balance, interest rate, and time remaining on your current home loan. 

Carefully consider the timing of your rate and term refinance. If you have a fixed-rate mortgage and interest rates have gone up since you locked that rate in, refinancing may not make financial sense. But if rates have gone down, or if you have an ARM and are looking to eliminate the risk of rising rates, now might be the time for a rate and term refi.  

Step 2: Research and Compare Lenders

Your original/current lender might provide the most favorable refinance option, but you can use another lender if they can provide better interest rates or terms. It’s a good idea to reach out to a few lenders to explore the different refinance product options that may be available and compare the different rates and fees each lender may offer. Look for lenders with good reviews from satisfied customers, and request a closing cost estimate to help you understand the potential costs that each lender may charge, so you can compare options. This can help you choose the refinance offer that works for you. 

Some lenders may use a soft pull to check your credit report. This does not impact your credit score. Other lenders may use a hard inquiry to check your credit, which may decrease your score slightly. However, checks by multiple lenders during the same time period (around 45 days for lenders using the FICO model 8 and newer) are typically counted as one inquiry, so you can shop multiple lenders without taking individual hits to your credit score.[5]

Step 3: Submit Your Refi Application with Required Documentation

Once you have chosen a refinance lender, you can submit the full application, with supporting documentation, to that lender. 

Step 4: Underwriting 

Underwriting is the process of thoroughly reviewing a loan application and the applicant’s financial situation to confirm that the applicant qualifies for the loan under the proposed terms. 

This can include a credit check, as well as verification of income, assets, and employment.

The lender also needs to confirm that the property qualifies for refinancing. This part of the underwriting process can include a title check to make sure there are no legal issues or liens that could interfere with the refinance. The lender may also order a home appraisal to confirm the value of the property. This value is important for establishing the amount the lender can loan against the property. 

Step 5: Close the New Loan

After underwriting is complete, the lender drafts the new loan documents for your signature. These documents will likely need to be signed in front of a licensed notary who verifies your identity and witnesses your signatures. 

With the paperwork signed, the new loan can be funded and the existing loan paid off. 

Pros and Cons of Rate and Term Refinancing

The potential benefits of rate and term refinancing include:

  • The possibility of lower interest rates and reduced monthly payments.
  • The opportunity to shorten or extend the loan term to suit your financial goals. 
  • Exchanging an ARM for a fixed-rate mortgage could make your monthly payments more predictable over the long term, while potentially saving money on interest increases over time. 

The potential drawbacks and risks of rate and term refinancing include:

  • Refinancing comes with closing costs.
  • A longer loan term would delay the free-and-clear ownership of your home.
  • A longer loan term or a higher interest rate could increase the total interest paid over time.

Final Thoughts on Rate and Term Refinancing

Rate and term refinancing can be a powerful financial tool for homeowners who want to reduce their mortgage payments, secure a lower interest rate, or adjust the length and structure of their loan. 

While it does come with costs and requires careful consideration, a well-timed refinance can lead to significant long-term savings and improved financial stability. 

As with any major financial decision, it’s important to evaluate your goals, crunch the numbers, and compare offers from multiple lenders to find the best mortgage solution for you.