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.

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 both rate-and-term and cash-out refinancing, the borrower must weigh the pros and cons of each before making any final decisions.

The potential benefits of rate-and-term refinancing include securing a better interest rate and more amenable terms 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. There are several ways to exercise a rate-and-term option.

For example, upon seeing interest rates drop, a homeowner who has been paying their 30-year mortgage for 10 years already might want to take advantage of the new rate. One option would be to refinance the balance left on their original mortgage at that lower rate for a new 30-year full term. The new loan would have lower monthly payments, but it would essentially be like starting over with a lower rate—and adding ten years to the time it would take to pay off the mortgage (10 years of the first mortgage, plus 30 years of the new one: 40-year total).

Or, they could use the rate-and-term refinancing option to pay the new, lower market rate and negotiate a 15-year mortgage. The monthly payments would be higher than with their original 30-year term, but their interest would be lower. What's more, they would save five years of payments (10 years of their original mortgage, plus 15 of the new one: 25-year total).

Cash-out refinancing, on the other hand, takes equity from the home for the homeowner to make use of. This works best when the overall value of the home has increased because of rising real estate values, but it can also be done if the homeowner is well along in the mortgage and has paid in significant part of its equity. In the process, a cash-out refinance will increase the principal that is owed 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.

When considering any of these options it's important to calculate all the implications carefully and decide how they compare to keeping your current mortgage.