Right now is a great time to discuss the rate and term refinance because today’s historically low interest rates make this an option that homeowners shoudn’t overlook.Simply put, a rate/term refinance, also known as no cash-out refinance, is a mortgage that’s used to lower a current borrowers interest rate or payment. You can also use rate and term refinancing to build equity faster by moving to a shorter-term loan, like 30 to 15 years, or move to a longer-term loan with lower payments. And if you currently have an adjustable rate mortgage, rate term refinancing now can offer stability with a historically low rate for years to come.
How Does a Rate and Term Refinance Work?
Rate and term refinancing can mean one or the other, or both. Basically, applicants negotiate a new mortgage to pay off the balance of their old mortgage at either a lower interest rate, a different-term length of the loan or both. Rate and term refinance loans don’t allow applicants to get much cash back – no more than 1-2% or a maximum of $2000 at closing. If an applicant wants more cash then they should consider cash-out refinancing. Rate/term refinancing typically carries lower interest rates and thus lower payments than the same loan amount for a cash-out refinance, however.
Whenever borrowers refinance they will always encounter closing costs, though the closing costs can often be rolled into the mortgage balance. In reality, mortgage lenders who promote ‘no-closing-cost’ refinance loans actually mean the closing costs are covered by including them in the loan balance or by charging the applicant a slightly higher interest rate.
The big question with rate and term refinancing is exactly how much are your closing costs and how long will it take for the future savings on your refinanced payment to cover those costs? Consider the following principal and interest payments on a $200,000 30-year fixed rate loan at various interest rates:
Interest Rate Monthly Payment Comparison
7% – $1330
6.5% – $1264
6% – $1200
5.5% – $1136
5% – $1074
4.5% – $1014
4% – $955
3.5% – $898
If the closing costs of your $200,000 refinance are the national average of about $2400, and you’re able to reduce your interest rate from 6% to 4.5%, you will save about $186 per month on your payment – and recover your closing costs in 1 year and 1 month. After that, the savings are all yours. If you reduce your rate all the way from 7% to 3.5%, you will save $432 on your payment and recover those same closing costs in less than 6 months. Doing the math on your own refinancing scenario will help you determine the right option for you.
Is Rate/Term Refinance Always a Smart Option?
In some instances, a rate term refinance does not make sense. For example, if you do not lower your rate much or your closing costs are unusually high, recouping your closing costs may take much longer. If you don’t expect to keep the mortgage or the home for long, refinancing may cost more than staying with your existing mortgage. Again, doing the math will help you make a good decision.
To qualify for a refinance, you must meet the credit, financial and home equity criteria of your lender. In many cases, a rate and term refinance can be obtained with a credit score as low as 620 and a loan to value ratio (LTV or the amount of loan as a percentage of the value of house) up to 95%. Cash-out refinance requirements are usually stricter, with minimum credit scores of 680 to 700, LTV’s no higher than 80%, and excellent payment histories.
After making the decision to refinance, you can work with any lender you choose. It does not have to be your present lender. Just be sure to research your options and do your homework … especially your math … before choosing the refinancing option that works best for you. If you have an older loan and are paying rates much higher than recent historic lows, it’s time to use a loan calculator, research your options, and get ready to reduce your payment to levels you may not believe.