With low interest rates and many new financing opportunities available to homeowners, a rate and term refinance can be a great tool for anyone looking to lock in monthly savings. At its most basic level, a rate and term refinance allows you to modify the terms of your current mortgage and switch them to loan terms that are more favorable. Not only can electing to pursue a rate and term refinance potentially help you capitalize on new interest rate changes, or adjust the length of your loan term, it can also help you boost your everyday cash flow and help you put more money back in your pocket by lowering your monthly payments.
What Is A Rate And Term Refinance?
A rate and term refinance serves as a means through which to secure better loan terms. It effectively allows you to swap out your current mortgage for a new mortgage agreement that offers more attractive numbers and financing terms. If you’re looking to take advantage of rate changes that have occurred since you first secured a loan, or are having trouble making monthly mortgage payments, you may wish to pursue one.
The mechanics behind a rate and term finance are relatively simple to understand at their core as well. You essentially obtain a new loan, use it to pay off the remaining balance on your previous mortgage, and then begin to make payments on the new loan after refinancing. Applying for a rate and term refinance offers you the opportunity to possibly reduce your monthly payment, lower your interest charges, or choose to increase or decrease the time to pay off your loan.
Reasons To Get A Rate And Term Refinance
There are many reasons that a borrower may wish to secure a rate and term refinance, several of which may quickly stand out to homeowners at a glance. For example:
- Lower interest rates
- Smaller monthly mortgage payments
- More favorable loan terms
- Obtaining a different loan type (i.e. switching from an ARM to fixed-rate mortgage)
- Reducing total interest fees
- Building equity in your home
- Doing away with mortgage insurance
Rate And Term Finance Requirements
As when applying for any home loan, individual lenders will require you to meet certain minimum qualifications. Several common requirements that you may expect to encounter as you work to refinance your mortgage rate and term are as follows:
- Credit score: Lenders typically look for a credit score of 620 or higher, or 580 in the case of FHA loans, along with a strong credit history.
- Home equity: To secure the best interest rates, you’ll want to hold off on refinancing until you possess at least 20% equity in your home. However, it is possible to refinance with less home equity if you so desire.
- Debt-to-income ratio (DTI): The lower your DTI the better – ideally, your debt-to-income ratio should be 30-50% or below prior to submitting a rate and term refinancing application.
- Closing costs: Closing costs, or additional fees paid at the time a property is purchased, can account for as much as 2% – 3% of the cost of a loan. Lenders will require you to pay them as part of refinancing, though homeowners with sufficient equity in their home may be able to include these costs within the refinanced loan itself.
What Does A Rate And Term Refinance Cost?
The costs of refinancing a home are worth keeping in mind as you think about a rate and term refinance as well. As with a first mortgage, costs are comparable on a new mortgage, sitting around 2% – 3% of the total mortgage amount, although you won’t need to pay for a home inspection. A refinancing calculator can help you compute your closing costs, which often include fees for common expenses such as:
- Loan origination fees
- Loan application fees
- Credit reports
- Home appraisal
- Title search
- Recording fees
- Reconveyance charges
Closing costs will be due at the time that you close upon your refinancing. Noting this, it’s a good idea to plan and prepare for them well in advance of signing.
How To Get A Rate And Term Refinance
Obtaining a rate and term refinance is similar to obtaining a mortgage in that it can take several weeks’ worth of time to pursue. You’ll also want to allot time up-front to research interest rates, loan terms, and prospective lenders as well. Steps involved in the process are:
- Applying to refinance: Once you’ve researched a lender and compared loan terms and mortgage rates, you’ll need to submit an application for refinancing. Your lender will ask you to submit paperwork such as your two most recent bank statements, pay stubs, and W-2 forms. Self-employed individuals may be required to provide additional documentation.
- Locking in a new loan rate: As part of the process, you’ll be given a loan estimate by your lender after applying for a refinance, which provides an estimate of costs and fees associated with your loan. You will also be given the choice to lock in your mortgage rate, as interest rates can change every day, for as long as 30 or 60 days into the future.
- Underwriting the loan: Upon submission of an application, your lender will begin the loan underwriting process, which involves confirming your employment, income, and personal information, and conducting background checks and verifications to ensure that you can make loan payments. During this underwriting process, you will be asked for additional information and documents, which should be provided in timely fashion. Your lender will also request a home appraisal to confirm your property’s worth, and ensure that it conforms to the amount of proposed money to be lent.
- Closing on the mortgage: After your lender successfully completes underwriting, you’ll be supplied with a Closing Disclosure that defines the terms of your refinancing and your lender will arrange to schedule your closing date. Closing presents a final opportunity for you to review and double-check all refinancing documents, or ask any questions that you may have, before signing papers. Be sure to bring a photo ID, a copy of your Closing Disclosure, and proof of wire transfer or a cashier’s check to cover closing costs to this meeting, at which you will complete your refinance.
Rate And Term Refinance Vs. Cash-Out Refinance
It’s not necessary to adjust your interest rate or loan term when you choose to refinance. If you’d prefer, you can also use a cash-out refinance to take money out of your home equity instead.
Under the terms of a cash-out refinance, you effectively agree to accept a higher principal loan balance but remove and pocket the difference in cash. A cash-out refinance basically allows you to take money that you’ve built up in equity and put it back in your hand for repairs, renovations, or any other pressing financial needs.
Whether you choose a rate and term refinance or cash-out refinance, you’ll wind up paying off your old mortgage loan and taking on a new loan with different terms. Both provide opportunities to switch to a new lender and switch your interest rate or loan term.
If you elect to pursue a cash-out refinance though, you’ll agree to accept a higher principal loan balance, and receive a cash payment several days after closing. Note that you’ll need to have built up a minimum amount of equity in the home before you can qualify for a cash-out refinance as well.
Is A Rate And Term Refinance Right For You?
Ultimately, which makes the most sense: A rate and term refinance vs. cash-out refinance? That’s a question that largely depends on your individual needs and situation.
If you’re simply looking to secure a lower monthly interest rate or payment, a rate and term refinance may make the most sense for your household. If you’re looking for a quick way to get cash back in hand, consolidate debt, or pay for a major expense though, a cash-out refinance may instead be the best choice for you.
A decision on how to refinance often depends on a number of differing market and individual household factors. To determine which option presents the best choice, you can start by taking a closer look at our refinance calculator. Once you’ve made a decision though, we’re happy to report that it’s easy to get started with your refinancing. You can begin the application process online.