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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Rate and Term Refinance

What it is:

A rate and term refinance occurs when a borrower replaces one mortgage with another mortgage that has a different maturity and interest rate.

How it works (Example):

For example, let's say John Doe bought a house 10 years ago for $250,000. He put $50,000 down and borrowed $200,000. His mortgage is for 30 years at 5%, making the payment about $1,199 a month.

At the end of the tenth year, John notices that interest rates have gotten a lot lower and that he can get a mortgage for just 3%. However, he's been making ten years of payments and now only owes about $167,000 on the loan.

Typically, the bank will let John refinance the loan at 3% for another 30 years, making the monthly payments just $705. But John wants to retire soon and doesn't want to "start all over" with another 30 years of making house payments. So, he does a rate and term refinance by borrowing $167,000 at 3% for just 20 years (the amount of time originally left on his mortgage). This makes the payments $928 a month—still lower than his original payment, thanks to the break in the interest rate—but he'll have the house paid off sooner.

Why it Matters:

Rate and term refinancings usually happen when interest rates drop. Their interest rates can be variable or fixed.

Sometimes when borrowers refinance, they borrow additional money for vacations or renovations; rate and term refinancings usually do not involve that.
 

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