The Ultimate Guide to a Rate-and-Term Refinance: Lower Your Rate, Pay Off Your Loan Sooner

What Is a Rate-and-Term Refinance?

A rate-and-term refinance replaces your current mortgage with a new one that has different terms. Typically, homeowners use this strategy to secure a lower interest rate or shorten the length of their loan. Unlike a cash-out refinance, this option does not provide access to home equity for spending. Instead, all funds go toward paying off the existing mortgage and covering closing costs.

This refinancing method can also involve changing loan types. For example, many borrowers refinance from an adjustable-rate mortgage (ARM) to a fixed-rate loan for added stability. Overall, rate-and-term refinancing is a smart move when you’re aiming to reduce interest expenses or meet changing financial goals.

Benefits of Rate-and-Term Refinancing

Lower Your Monthly Mortgage Payment

Securing a lower interest rate is one of the most common reasons for refinancing. A reduced rate directly translates into smaller monthly payments. In some cases, homeowners also extend their loan terms to spread payments over a longer period. While this may increase the total interest paid over time, it can offer short-term budget relief.

As a bonus, monthly savings can be redirected toward other debts. This strategy creates a snowball effect that accelerates overall debt repayment.

Shorten Your Loan Term

Opting for a shorter loan term allows you to build equity faster and pay off your home sooner. Although the monthly payments may be higher, the total interest paid over the life of the loan is significantly less.

For example, switching from a 30-year to a 15-year mortgage could save tens of thousands of dollars in interest. Shorter terms are ideal for borrowers focused on long-term financial freedom.

Convert from an ARM to a Fixed-Rate Mortgage

Adjustable-rate mortgages often start with lower rates, but they can rise unpredictably. Refinancing into a fixed-rate loan brings stability to your finances. Fixed-rate payments remain the same throughout the loan term, offering peace of mind and protection against future rate hikes.

Consolidate First and Second Mortgages

Homeowners with both a primary mortgage and a second mortgage or HELOC may benefit from consolidation. To qualify, the second mortgage must be at least 12 months old with no draws over $1,000 in the past year.

Combining these loans simplifies repayment and may reduce your overall interest rate. It also streamlines your monthly finances by eliminating multiple payments.

Facilitate Divorce Buyouts

In the event of divorce, one spouse may refinance the mortgage to remove the other from the loan. This option becomes available once the divorce is finalized. The remaining borrower must qualify for the new loan independently.

Many lenders treat this as a rate-and-term refinance instead of a cash-out, provided certain conditions are met. This classification helps maintain favorable loan terms.

Eligibility and Guidelines

FHA Rate-and-Term Refinance

FHA loans allow refinances up to 97.75% loan-to-value (LTV) for owner-occupied homes. Eligible items include:

• The existing first mortgage
• Second liens that are seasoned (12+ months) with no large recent draws
• Closing costs and prepaid items

However, any cash back to the borrower must be incidental—typically under $500. Anything more would convert the loan into a cash-out refinance.

VA Rate-and-Term Refinance

VA loans are available to qualified veterans and active service members. With a VA rate-and-term refinance, you can borrow up to 100% of your home’s value.

Key criteria include:

• Prior occupancy must be certified
• You don’t need to currently live in the home
• Any second mortgage must be subordinated, not paid off with refinance funds

This program helps veterans improve their financial position without losing their VA loan benefits.

Conventional Rate-and-Term Refinance

Conventional loans typically allow up to 95% LTV, depending on the lender and program. These loans often require higher credit scores compared to FHA or VA options.

If your new loan exceeds 80% LTV, you may need private mortgage insurance (PMI). However, refinancing could allow you to remove PMI if your equity has increased.

Considerations and Potential Drawbacks

Closing Costs

Refinancing isn’t free. You’ll encounter several fees, including:

• Origination charges
• Appraisal fees
• Title insurance
• Lender processing fees

To determine if refinancing makes financial sense, perform a break-even analysis. This calculation shows how long it takes for your monthly savings to outweigh the upfront costs.

Loan Term Reset

One downside to refinancing is starting a new repayment schedule. For instance, moving from a 22-year remaining term to a new 30-year loan means paying more interest overall.

To avoid this, consider choosing a loan term that matches your current one. Many lenders offer flexible terms in five-year increments.

Impact on Credit Score

A rate-and-term refinance involves a hard credit inquiry, which may temporarily lower your score. Opening a new account also affects the average age of your credit history.

However, responsible payment history on the new loan can offset this dip over time.

Frequently Asked Questions

Can I receive cash back with a rate-and-term refinance?

Yes, but only in small amounts. This is often referred to as incidental cash back. Freddie Mac will sometimes allow up to 1% of the loan amount. Fannie Mae allows the lesser of $2,000 or 2%. FHA and VA allow less.

How does refinancing affect my mortgage insurance?

With FHA loans, mortgage insurance premiums (MIP) typically continue unless you refinance into a conventional loan. For conventional loans, PMI may be dropped if your new LTV is at or below 80%.

Is it possible to remove a co-borrower through refinancing?

Yes. Refinancing allows for the removal of a co-borrower, assuming the remaining borrower qualifies independently. In cases of divorce, you’ll also need a finalized decree to proceed.

Conclusion

Rate-and-term refinancing offers homeowners a practical way to lower monthly payments, shorten loan terms, or switch loan types. It’s an especially effective strategy during periods of low interest rates or major life transitions like divorce.

By understanding the benefits, requirements, and trade-offs, you can make a confident decision that aligns with your long-term goals.

For more insights, read our cornerstone guide Refinancing Your Mortgage: The Complete Guide, or explore related options like an FHA Streamline, VA IRRRL, or Cash-Out Refinance for Debt Consolidation.

As always, speak with a qualified mortgage advisor to ensure you’re choosing the best path for your financial future.