Rate and Term Refinance

What is 'Rate and Term Refinance'

Rate and term refinance is the refinancing of an existing mortgage for the purpose of changing the interest and/or term of a mortgage without advancing new money on the loan. This differs from a cash-out refinance, in which new money is advanced on the loan. Rate and term refinances can carry lower interest rates than cash-out refinances.

BREAKING DOWN 'Rate and Term Refinance'

Rate and term refinancing activity is driven primarily by a drop in interest rates, while cash-out refinance activity is driven by increasing home values. Because there are pros and cons associated with a rate and term and cash-out refinancing, the borrower must weigh the pros and cons of each before making any final decisions.

How Rate and Term Refinancing Compares with Other Options

The potential benefits of rate and term refinancing include securing a better interest rate and more amenable term on the mortgage, though the same principal balance will remain. Such refinancing could lower the payments the homeowner is responsible for, or potentially set a new schedule to pay off the mortgage more quickly.

For example, upon seeing interest rates drop, a homeowner who has been paying their 30-year mortgage for 15 years already might want to take advantage of the new rate without. They could refinance the loan at that lower rate for a new 30-year full term—but it would essentially be like starting over with a lower rate. By using the rate and term refinancing option, they might pay the new market rate, but the term would be for the remaining 15 years only. The monthly payments would be higher than taking a new 30-year term, but the payments would be lower than what they negotiated initially. The homeowner would have the same balance to pay off; however, they would typically finish sooner within the remaining term from the original financing.

Cash-out refinancing, on the other hand, takes equity from the home for the homeowner to make use of. This might be done as the overall value of the home increases, but in the process, a cash-out refinance will also increase the principal that remains on the mortgage. This might call for a reappraisal of the home to gauge its new value. Homeowners might seek such refinancing in order to gain access to capital from the value of the home that they otherwise might not see until the home was later sold.

A converse option called cash-in refinancing involves putting more money toward the settlement of the mortgage in order to reduce any remaining principal.