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What is a Rate and Term Refinance?

A rate and term refinance can lower your mortgage rate or change the time you'll be paying off your loan.

Abby Badach Doyle
Hal M. Bundrick, CFP®
Jeanette Margle
Updated
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With a rate and term refinance, you exchange your old mortgage for a new one that (hopefully) leaves you in a better financial position.
You may be able to accomplish one or more goals with a rate and term refinance, such as:
  • Lowering your monthly payment
  • Reducing the amount of interest you pay over the long term
  • Building equity in your home and paying it off faster
  • Changing the type of loan you have, from an adjustable-rate to a fixed-rate mortgage or an FHA to a conventional loan, for example
  • Eliminating mortgage insurance

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When to consider a rate and term refinance

Several situations might prompt you to consider a rate and term refinance. Mortgage rates moving significantly lower might be one. Having an adjustable-rate mortgage approach the end of its initial fixed-rate guarantee could be another.
Other scenarios that might present an excellent opportunity to refinance your home loan to a better rate or a different term include:

💳 When your credit score improves or you start to make more money

With a higher credit score than when you closed your current loan, you may earn a lower mortgage rate. Or, if your earnings increase, you may opt to shorten the loan term to pay off your mortgage faster. (A shorter mortgage term raises your monthly payments, but you’ll pay less interest over time.)
🤓 Nerdy Tip
Want to refinance to a shorter mortgage? While 15- and 20-year terms are common, some lenders let you customize the number of years you want to pay. A custom term length can help sync up your mortgage payoff date with other goals, like a retirement date.
» MORE: Best mortgage refinance lenders

⚖️ When the break-even point matches your plans

You’ll have to pay closing costs and fees when you refinance, so consider the time it will take to recoup those costs with how long you intend to remain in your home. That determines your refinance break-even point. If your break-even point falls well within your stay-here plans, a refi might make sense.

🏠 When you have at least 20% equity in your home

Mortgage insurance is a fee you pay to protect the lender's interest in your home loan. In many cases, mortgage insurance can be eliminated once you have 20% equity. Refinancing is one way to make that happen.
» MORE: When to refinance your mortgage

Rate and term vs. cash-out refinancing

The primary difference between a rate and term refi and a cash-out refinance, other than the money you pocket, is this:
  • A rate and term refi maintains or reduces your current amount of housing debt.
  • A cash-out refi, where you convert some of the equity out of your home into cash, typically increases your debt.
However, you may be able to draw some cash out of a rate and term refinance, without it being considered a cash-out refi. Generally, it's 1%-2% of the loan value or $2,000, whichever is less.
» MORE: Calculate your potential refinance savings

Rate and term refinance guidelines and costs

In general: The best refinance mortgage rates go to borrowers with high credit scores and a low loan-to-value (LTV) ratio. LTV compares the size of the mortgage with the value of the property.
A minimum credit score of 620 is often preferred by rate and term refinance lenders.
🤓 Nerdy Tip
What if you have bad credit? A refinance is possible, but you’ll have fewer options and will pay higher rates and fees. FHA loans, backed by the Federal Housing Administration, accept scores in the 500’s. See our picks for the best bad credit home loans.
» MORE: How to refinance a mortgage with bad credit
What are the costs of a rate and term refinance? You could pay 2%-6% in closing costs for a refinance. That's another good reason to shop a few lenders to see who offers the best combination of mortgage rates and low fees.
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