Rate and Term Refinance

refinance

In the mortgage realm, a “refinance” refers to the replacement of an existing mortgage(s) with a new home loan. The refinance loan will come with a new interest rate (ideally lower) and mortgage term. The existing mortgage is effectively paid off by the opening of the new refinance loan, with the old balance being transferred to the new loan.

Think of it this way – you are re-financing your mortgage, meaning you are obtaining new financing for an existing loan.  The issuer of the new mortgage pays off the old loan with the proceeds from the new loan so everyone is square.

When you obtain new financing, you can either go back to your original mortgage lender or shop around with other banks and lenders.  Generally, it’s best to see what other lenders can offer. Either way, when you refinance you are seeking out new financing terms for one reason or another.

Tip: How does refinancing work?

What type of refinance are you looking for?

The simplest type of mortgage refinance is called a “rate and term refinance” because the borrower is simply changing the interest rate and term of the loan, and perhaps the loan program, but not the loan amount.  It may also be known as a “no cash out refinance” for this reason.

Typically, a borrower will consider a rate and term refinance if their current mortgage is an adjustable-rate mortgage and the fixed period is due to expire.  Or if mortgage rates have dropped significantly since they originally took out their fixed-rate loan.

An example would be a 3-year ARM. The first three years are fixed, and then the mortgage becomes adjustable, based on the margin and index tied to the loan. At or before this first adjustment, borrowers will often look to refinance to avoid the impact of the fully indexed rate, assuming it’s higher than the initial rate.

[When to refinance a home mortgage.]

Look at this example of a rate and term refinance in action:

Loan type: 3-year ARM
Loan amount: $500,000
Start rate: 2.875%
Margin: 2.25
Index: 2%
Fully indexed rate: 4.25%

Most short-term ARMs are hybrids with 30-year terms. In the above scenario, the first three years are fixed and the remaining 27 years are adjustable. This may be represented as a 3/1 ARM.  After three years, the interest rate adjusts to the sum of the margin and index, and can adjust annually both up or down.

Instead of getting stuck with a higher rate, the borrower can obtain new financing that is lower than the fully-indexed rate.

Your Mortgage Rate May Rise If You Don’t Refinance

If the borrower doesn’t refinance after three years, their interest rate will jump from 2.875% to 4.25%, using our example from above. There are initial rate caps that may limit the amount the interest rate can actually rise (or fall), but it usually won’t be sufficient to keep the mortgage rate in check in a rising rate environment.

So most borrowers will likely look to refinance their existing loan with a new loan with a longer fixed period and a lower interest rate. Or simply refinance into another ARM with an initial teaser rate.

If you happen to be replacing a fixed-rate mortgage with another fixed-rate mortgage, you may want to shorten the term while you’re at it, assuming you want to pay off the loan on schedule. Otherwise you’ll be looking at a fresh 30 years on the new loan.

Of course, a shorter term will require a higher monthly payment in most cases, so it’s not always a viable option. Sometimes it’s good enough just to get the rate and associated monthly payment down.

As noted, homeowners have the choice of refinancing their existing loan with their current mortgage lender or shopping rates and loan programs with a new bank, lender, or broker.

It is always recommended that you shop around when looking to refinance, as rates, closing costs, underwriting requirements, and loan programs can and will vary greatly from lender to lender over time.

Consider Closing Costs Associated with a Refinance

Although there will be closing costs associated with the new refinance mortgage, the lower interest rate should eventually offset these costs and benefit the borrower in the long run.  This is known as the “break-even point of the refinance” – essentially when the closing costs are offset by lower monthly mortgage payments, so subsequent payments save the homeowner money each month.

Think of it this way. If the homeowner stays in their adjustable-rate mortgage at 4.25%, they will pay $2459.70 a month in principal and interest payments. If they choose to refinance into a lower fixed-rate mortgage, say 3.5%, they’ll pay $2245.22 a month in principal and interest payments. That’s a savings of about $215 a month.

Sure, there may be closing costs associated with a refinance, but the monthly savings will cover those costs over time. Additionally, you might even be able to execute a no cost refinance whereby you pay no closing costs in exchange for a slightly higher-than-market rate, but still receive a rate well below your existing one.

These monthly savings are exactly why a homeowner would opt to carry out a rate and term refinance.  Of course, if they only stayed in the home/mortgage for a year or two, perhaps they wouldn’t recoup the costs associated with the refinance.  In that case, it would be a poor decision to refinance.  So always do the math and look ahead before agreeing to carry out a refinance.

[The refinance rule of thumb.]

Why Homeowners Refinance Their Mortgages

  • To obtain a lower mortgage rate
  • To swap an ARM for a fixed mortgage
  • To reduce monthly mortgage payments
  • To tap their home equity for cash
  • To consolidate combo mortgages
  • To consolidate other debt
  • To pay off high-interest rate credit cards and other loans
  • To remove someone from a loan (ex-spouse)
  • To remove mortgage insurance
  • To switch loan programs, such as FHA to conventional
  • To shorten the term and pay off a loan faster

Tip: Most mortgage lenders will let a borrower take out incidental cash-out (home equity) of the lesser of 2% of the loan amount or $2,000 – $5,000, and still consider it a rate and term refinance. Anything beyond that would probably be considered a cash-out refinance, which is the other popular type of mortgage refinance available.


33 Comments

  1. sam March 2, 2013 at 10:12 am -

    dealing with 2 lenders one is offer 25yrs 3.99% and other 30yrs 3.75%. which is better over all.

  2. Colin Robertson March 2, 2013 at 11:31 am -

    Sam, a shorter term fixed mortgage should have a lower rate. For example, 15-year fixed mortgages should always price lower than 30-year mortgages.

    So in your scenario, the 25-year loan should be priced lower than the 30-year.

    However, shorter term fixed loans can result in you paying less interest, meaning the 25-year loan could save you money over the entire term of the loan.

    But when rate shopping, you should find that shorter term loans come with lower rates.

  3. Trevor July 13, 2013 at 3:42 pm -

    Thinking about doing a rate/term refi on my current mortgage. I got it back in 2003 at a rate of 5.25%. It’s a 30-year fixed. I’ve been offered a rate of 4.5%. Is that a good deal?

  4. Colin Robertson July 14, 2013 at 2:39 pm -

    Seeing that you’ve held the loan for a decade, you’ve already paid quite a bit of interest. And if you refinance to another 30-year loan, you’ll pay a lot more interest, assuming you hold the loan to term. With the two rates being not all that far off, a better idea might be to look at a shorter-term loan, such as a 15-year fixed. You’ll get a lower interest rate too. But if you plan to move anytime soon, as opposed to paying off the loan, you might not want to invest more into your home. Use some calculators to see the actual math before making a decision either way.

  5. Jerrod July 29, 2013 at 11:02 am -

    A rate and term loan only makes sense if interest rates are significantly lower than your current interest rate. There was a good window of opportunity there for a few years, but it seems to be over for most people today, unless your rate is above 6% or so.

  6. Tom August 14, 2013 at 10:51 pm -

    Another good reason to do a rate and term refi is to reduce the loan term. e.g. Going from a 30-year loan to a 15-year loan to save a ton of money on interest, especially if the new rate is low enough to offset the increase in payment.

  7. Florence August 25, 2013 at 6:34 pm -

    My current rate is 5.25% on a 30-year loan. I’ve had it since 2010. Should I refinance to another 30-year fixed at 4.625% or go with an ARM instead?

  8. Colin Robertson August 26, 2013 at 2:11 pm -

    It depends on how much cheaper the ARM is, how long it’s fixed for (5/7/10 years), and if you’re okay with it adjusting higher. Fixed loans come with peace of mind, while ARMs give you immediate payment relief. Depends what you’re looking for and what your goal with the property is.

  9. Zuma September 14, 2013 at 8:14 pm -

    Don’t refinance to an ARM unless you know you’ll be out by the time it becomes adjustable. Rates are only going higher!

  10. Joe January 18, 2014 at 5:20 am -

    Are rate and term refinances cheaper if you don’t take any cash out?

  11. Colin Robertson January 20, 2014 at 9:22 pm -

    Generally, yes, the mortgage rate will be lower for a rate and term refi. Additionally, you’ll typically have added flexibility, such as a higher LTV allowance, and/or a lower credit score requirement.

  12. Aurelio February 18, 2014 at 12:55 pm -

    Can you do a rate and term refinance with no seasoning? I recently purchased a home and want to switch loan programs.

  13. Colin Robertson February 19, 2014 at 5:51 pm -

    Some lenders may make you wait 120 days, or 4 months, before getting a rate and term refinance, but others have no seasoning requirement. Shop around.

  14. Cheryl June 10, 2014 at 11:18 am -

    If I am paying off a home equity line of credit on a home i paid cash for originally, am I able to apply for a rate and term refinance? My loan officer told me it would be considered taking cash out.

  15. Colin Robertson June 10, 2014 at 1:30 pm -

    Cheryl,

    If the home equity line wasn’t a purchase-money HELOC, that is, used to buy your home, lenders consider it cash out when you refinance if it’s a subordinate mortgage. If it’s in the first-lien position it may be eligible as rate and term.

  16. Gin September 4, 2014 at 12:05 pm -

    Question, purchased a home 7 years ago with conventional financing. Lost this home in foreclosure 5 years ago.
    Purchased another home 4 years ago using FHA financing. I now want to refinance to conventional financing to eliminate the mortgage insurance. I am being told I cannot as I have to have the FHA loan a minimum of 5 years. Is this correct? Any way around it?
    Thanks

  17. Colin Robertson September 4, 2014 at 5:17 pm -

    Gin,

    Maybe they’re telling you that you have to pay MI for a minimum of five years if you stay with the FHA. You can refinance away from the FHA and drop the mortgage insurance whenever, assuming you qualify for a conventional loan. But that might be the issue at hand. Do the math to see if the rate change on the new loan and MI drop makes sense. Also consider how much longer you have to pay MI on your current loan if the rate is lower, you could avoid refi fees and save money potentially.

  18. Karen September 16, 2014 at 1:21 pm -

    Having no intention initially of staying in our house longer than 5 years, we have a 40-year conventional loan with a 6.5% interest rate. With the drop in the market we have found ourselves staying into our 8th year, and would love to lower the interest and convert to a shorter term loan. We are no longer upside down, but still have a high LTV. Do you know if anyone is doing rate & term refis with a high LTV? We have great credit and have never missed a payment.

  19. Colin Robertson September 16, 2014 at 2:22 pm -

    Karen,

    It depends how high the LTV is, but there should be plenty of options, especially with programs like HARP out there. If you’re currently stuck at 6.5%, you can certainly do better and pay off your mortgage a lot quicker with a shorter-term loan. Do some shopping around to see what’s out there. Your home’s value might even be higher than you think.

  20. tom August 6, 2015 at 10:40 am -

    can home owners use an interest rate swap to convert the variable portion of a HELOC to a fixed rate if the if house is “under water”?

  21. Charles Desranleau August 23, 2016 at 12:28 pm -

    I am in foreclosure I need $380.000 to pay the lender off I just got an appraisal in May 2016 home is worth $585.000. I have a full time job $6200 at the end of each month. I live North of Edmonton in the Westlock County. I am just looking for a second chance I do not and cannot lose my home for the last 16 years. Thank You from my family and me.

  22. Loui October 11, 2016 at 12:10 pm -

    I want to pay off two mortgages taken out at different times. Is this a rate and term or cash out?

  23. Colin Robertson October 11, 2016 at 2:00 pm -

    Loui,

    It’s possible it could be treated as cash out if the second mortgage was a non-purchase money transaction.

  24. Evan December 28, 2016 at 10:00 am -

    Hey Colin,

    Great article. One question. I’m looking to pick up investment properties (most likely 5 unit+). I’m using private money to finance the deal (investor receives a promissory note) and want to pay back my investors via a refinance + equity position and % of cashflow. The route that makes the most sense to me is to get a cash-out refinance and use that 75% LTV to pay back the investors all or most of their investment. This would be done through increasing the value of the property through rehabs, raising rents, etc…
    The hurdle I see is that getting a commercial cash-out refinance can take as long as 2 years for seasoning for 20+ unit buildings.
    At the beginning of the article you mentioned “The existing mortgage is effectively paid off by the opening of the new refinance loan, with the old balance being transferred to the new loan.” So my question is could I get a term and rate refinance in order to achieve the same results? In essence, would bank 2 pay back Bank 1 (private lender) their loan balance? It sounds doable as none of the funds would be going to owner but to the original lender. The seasoning requirement for a term and rate refinance is much shorter and the numbers are better than most cash out refinances so if that works it seems like a great option to me. Just wanted to clarify.

  25. Colin Robertson January 3, 2017 at 9:35 am -

    Evan,

    My site is in reference to residential lending but the concept should be the same, you’re paying off the original lender’s loan and getting a new loan, thereby releasing the money owed to the first lender.

  26. Angela Rubeck May 23, 2017 at 12:43 pm -

    If someone was doing a refi and they were using funds to payoff an ex-spouse, is this considered a rate and term refi or cashout?

  27. Colin Robertson May 24, 2017 at 1:42 pm -

    Angela,

    Generally, if the proceeds exceed $2,000 it’s no longer considered a rate and term refi. It doesn’t really matter what the proceeds are for if they aren’t paying off an existing mortgage.

  28. LaCandice Early August 24, 2017 at 10:27 pm -

    I have a FHA loan it will be 5 years in Nov 2017 through WellsFargo . I called they told me that the PMI is not set to fall off until 2021 . How can I get it off sooner ? Should I look into refinancing ? Can I get the PMI off without refinancing ?

  29. Colin Robertson August 25, 2017 at 7:46 am -

    LaCandice,

    A refinance might be the easiest way, and it’s also possible to secure a lower interest rate in the process. The only other alternative might be paying down the outstanding balance on the FHA loan to get it down to 78% LTV, based on the original value of the home when you bought it. But that could require a lot of money depending on where your loan balance is relative to the original value.

  30. sara September 12, 2017 at 11:28 am -

    We are looking to purchase a house with a 5% conventional loan with a rate of 5.375% and were told in 6 months we could do a rate term refi to drop the rate and PMI fee would that be smart to do?

  31. Colin Robertson September 12, 2017 at 12:32 pm -

    Sara,

    What did they tell you would change in six months that would allow you to get a lower rate and drop PMI?

  32. Lourdes October 31, 2017 at 10:18 am -

    We want to refinance my mortgage, it is at 30 years fixed and 3.255. Additionally, we want to get extra money to pay some bills. the lender we are talking offer us a loan that has a trial period 6 months for the entire balance at 4.25% after the trail he said we” be in a better situation and we can get 3.3%, It is true that with this offer we can pay our debts and refinance and almost get the same interest rate but this refinance will be for 15 years, (ours is 30 years at 3.25%)
    My worries are how much I can trust the lender officer that we can get the interest rate of 3.3% and we have to pay only 1 thousand and some to get that rate. I’m sure what we are going to do to get all that he offered, but how a trust him if he can do his part. What really scares me is that after the 6 months, even when we did our work he can say that the market changed or came with others excuses and we get a higher rate. and we’ll be in the hot spot, we have to make decision soon. Advise, please. Thanks.

  33. Colin Robertson October 31, 2017 at 3:17 pm -

    Lourdes,

    I don’t know what he means by a trial? It sounds like two refinances to me, once to a 30-yr fixed then eventually to a 15-yr fixed? That would explain why the rate is much higher on the first refinance and lower on the second because 15-yr fixed mortgage rates are much lower. You and him are right that the market can change and rates can move higher during those six months, there is no guarantee. So it’s possible that 3.3% rate will not be available in the future. However, rates can also stay the same during that time or even go down. My question is why it seems he needs to refinance your mortgage twice? To make more money or for a legitimate reason?

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