Rate-and-term refinance refers to the refinancing of an existing mortgage with the primary objectives of changing the interest rate or adjusting the loan term, without the borrower taking out additional cash from the equity. This type of refinance is mainly aimed at either lowering the borrowing costs or reducing the loan duration.
Key Objectives
Lower Interest Rates
Refinancing to a lower interest rate is one of the most common reasons for a rate-and-term refinance. Lower interest rates can significantly reduce monthly mortgage payments and the overall cost of the loan.
Adjust Loan Terms
Changing the loan term—such as switching from a 30-year mortgage to a 15-year mortgage—aims to either pay off the loan faster or extend the payment period for more manageable monthly payments.
Comparison with Cash-Out Refinance
Definitions
- Rate-and-Term Refinance: Changes only the interest rate or loan term without taking additional cash.
- Cash-Out Refinance: Provides the borrower with a new, larger mortgage, converting part of the home’s equity into cash.
Use Cases
- Rate-and-Term Refinance: Suitable for borrowers who wish to reduce their loan costs or change the loan duration.
- Cash-Out Refinance: Ideal for those needing cash for major expenses like home improvements, debt consolidation, or other significant costs.
Equity Utilization
- Rate-and-Term Refinance: Does not significantly alter the outstanding principal amount.
- Cash-Out Refinance: Increases the outstanding principal, giving the borrower access to cash from home equity.
Examples
Example 1: Lowering Interest Rate
Jane initially took out a 30-year mortgage with a 5% interest rate. Five years later, she decides to refinance at a new 3.5% interest rate. This reduces her monthly payments and overall interest paid over the remaining loan term.
Example 2: Changing Loan Term
John has a 30-year mortgage but wants to pay off his loan quicker. He refinances to a 15-year mortgage, resulting in higher monthly payments but a lower total interest cost and debt freedom sooner.
Historical Context
In periods of declining interest rates, many homeowners opt for rate-and-term refinancing to take advantage of lower borrowing costs. Historically, refinance booms have occurred during economic downturns or periods of monetary policy adjustments by central banks.
Special Considerations
Closing Costs
Borrowers should consider the closing costs associated with refinancing, which can include appraisal fees, title insurance, and other related expenses.
Break-Even Point
The break-even point is crucial to determining if refinancing is beneficial. It is the point at which the savings from lower payments surpass the costs of refinancing.
Credit Score
A better credit score can qualify borrowers for more favorable refinancing terms. It’s advisable to check and potentially improve credit scores before applying for a refinance.
Related Terms
- Amortization: The process of paying off a debt over time through regular payments.
- Loan-to-Value (LTV) Ratio: A financial metric used to assess lending risk and compare the loan amount to the appraised value of the property.
- Adjustable-Rate Mortgage (ARM): A mortgage with an interest rate that may change over time, usually in relation to an index.
FAQs
What is the main difference between rate-and-term refinance and cash-out refinance?
Can I refinance with a high Loan-to-Value (LTV) ratio?
Is refinancing always beneficial?
Summary
Rate-and-term refinance provides an opportunity for homeowners to adjust their mortgage interest rate or loan term without taking out additional cash. It can lead to substantial savings and better loan terms, depending on individual financial objectives and market conditions. Understanding the distinctions between rate-and-term and cash-out refinance, evaluating the cost-benefit analysis, and considering credit implications can aid in making informed refinancing decisions.