Glossary

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Rate and Term Refinancing

Definition

A mortgage refinance that replaces the existing mortgage with a new one but does not disburse cash to the borrower. Rate and term refinancing is undertaken simply to improve on the terms of the old loan – reducing the interest rate is a popular goal.

Comparison to Cash-out Refi

Cash-out refinancing, on the other hand, involves replacing the old mortgage with a larger one and paying out the difference to the borrower.

Limited Cash-out Refinance

A variation on the rate-and-term refinance is called a limited cash-out refinance. The replacement loan is larger than the old loan because the costs of refinancing are included in its balance. However, because cash is not released to the borrower (except possibly very small amounts when the settlement documents are reconciled), some lending guidelines classify limited cash-out refinancing as a rate-and-term transaction. Others do not, but they refer to the loan as a limited cash out transaction and treat it the same way they do a rate-and-term transaction.

Rate Refinancing Explained

Rate and term refinancing changes the terms of a mortgage without adding any new money to the loan. This differs from cash-out refinancing, which refinances to a mortgage with a larger principal and pays cash back to the borrower. Rate and term refinancing does not change the amount of principal. It only changes the interest rate and/or the length of the loan.

There are several good reasons to consider rate and term refinancing. Perhaps interest rates have significantly dropped since you originally got your mortgage. You can refinance and get a better rate, which will save you money on your monthly payments.

Perhaps you have a 15-year fixed-rate mortgage but need lower monthly payments. You can use rate and term refinancing to turn your loan into a 30-year fixed-rate mortgage. This can also work for the opposite scenario. If you want to build equity more quickly, you can change from a 30-year fixed loan to a 15-year fixed, but remember this will result in a higher monthly payment -- although more of your monthly payment will go to principal. This difference is due to the long-term savings in interest of the 15-year product.

Look at the difference in payment with the products, but also compare the total amount paid.

 

 Term  Interest Rate  Loan Amount  Monthly Payment  Total Paid on Loan
 15-year fixed  6%  $160,000  $1,350.17  $243,030.83
 30-year fixed  7%  $160,000  $1,064.48  $383,217.48

If you choose rate and term refinancing, you can save some money up front by rolling in your closing costs. Although you do not get cash back with rate and term refinancing, you can receive up to 1 percent of the loan amount in cash at closing. If you are considering rate and term refinancing, be sure to talk with your lender or financial advisor to see if it is right for you.

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