What is Rate and Term Refinance?
A rate and term refinance occurs when a borrower replaces one mortgage with another mortgage that has a different maturity and interest rate.
How Does Rate and Term Refinance Work?
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 Does Rate and Term Refinance Matter?
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.