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Rate-And-Term Refinancing

Many homeowners stick to their current mortgage plans, get comfortable, and wait it out without realizing that they might be sitting on resources that they could use to quickly and effectively pay off their debts. Refinancing is an art to informed homeowners who know how to draw in their assets and approach their mortgage in a more efficient way. 

Rate-and-term refinancing is one of the most efficient refinancing schemes for mortgagors as its following strengths show:

  • They shorten the life of the loan so it doesn't hang over a homeowner's head.
  • They reduce the annual interest rates.
  • They reduce the monthly mortgage costs.
  • They enable you to switch from an adjustable-rate mortgage to a fixed-rate one, or vice versa.

Why Refinance?

When homeowners use rate-and-term refinancing effectively, they can weigh their options and decide the most cost-effective approach in settling their loan. Some homeowners prefer to pay off their mortgage in smaller monthly increments, even if that means a longer loan term. Others would rather reduce the loan term to get it over with and make pricier monthly payments in the process. Adjustable-rate mortgages (ARMs), for example, are ideal if you plan to move in for a few years since they're easier and cheaper to refinance within the adjustment period*.

*The adjustment period, typically 1 - 5 years, is the length of time the initial interest rate is subject to remain unchanged until the period expires.

Click here to learn more about refinancing.

How It's Done

Ideally, a rate-and-term refi should decrease your rates, monthly costs, and loan's life. One of the scenarios in which homeowners go for a rate-and-term refi is they'll switch from an adjustable-rate mortgage plan to a fixed-rate one to reap the benefits of a fixed interest rate lifelong when the final date of the adjustment period is about to pass. The best time to switch from an ARM to an FRM is when the economy's interest rates are at their lowest. In this way, they avoid high interest-prone ARMs and take advantage of better mortgage plans, possibly with the same lender. 

This aspect of efficiency makes rate-and-term refi ideal for homeowners seeking to reallocate their assets to better use and cut down on unnecessary costs.

Let's take a look at an example of a mortgagor making moves to shorten their loan term. Sue wants to cut down on her loan's lifespan and is willing to make larger monthly payments to do it. Her data is as follows:

  • Original loan amount: $300,000
  • Margin: 2.75%
    Note: The margin value is there to be added to the index value.
  • Index: 3.25%
    Note: The index value, when added to the margin value, gives you the fully indexed rate.
  • Fully indexed rate: 6%
    Note: The fully indexed rate is the sum of the index and margin values. After your adjustment period has passed, the interest rate on your monthly payments will potentially be of this magnitude.
Comparison of Sue's Mortgages
  Mortgage Type Loan Amount Interest Rate Loan Term Monthly Payments
 Current 3/2 Adjustable-Rate $300,000 4.75% 30 Years $833.3
 New 1-Year Adjustable-Rate $270,000 4.75% 15Years $1,500


In the above example, Sue took out a loan three years ago in the form of a 3/2 adjustable-rate mortgage. A 3/2 adjustable-rate mortgage means that the adjustment period for the interest rates to remain fixed is 3 years long. The number 2 refers to how frequently (in years) the interest rates reset after the first adjustment period has passed.

She switched to another mortgage plan that suited her financial situation better. The adjustment period on the new mortgage is 1 year long and the interest rates are set to change annually. By the time adjustment period of the first mortgage was over, Sue had made installments of up to $30,000. The larger monthly payments, in combination with the smaller loan amount due, raises the appraised value of Sue's home by lowering its loan-to-value. A lower LTV ratio meant that Sue had built equity for her home since the initial loan, which gave her a higher credit score, and more refinancing leverage.

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