What is Rate and Term Refinancing?
Life is anything but predictable, so a loan that was perfect for you a few years ago may no longer be ideal. Fortunately, you can refinance your loan in order to more closely match your current needs. If you take advantage of rate and term refinancing, the principal of your loan remains the same and only the interest rate and term are adjusted.
Rate and term refinancing gives you the opportunity to change the terms of your loan without adding more money to the loan. Other types of refinancing, such as cash-out refinancing, result in a loan with a larger principal and the opportunity for the borrower to get cash back. The amount of principal does not change as a result of rate and term refinancing, because as the name suggests, it only changes the length and/or the interest rate associated with the loan.
Why Choose Rate and Term Refinancing?
Now that you know how rate and term refinancing works, the question becomes, when is the best time to take advantage of this option? If interest rates have significantly dropped since you originally took out your loan, you may want to refinance and get a better rate. A lower interest rate will save you money in the long run by lowering your monthly payments.
In addition, if your current payment plan lasts for 15 years, but you want to pay less each month, you can use rate and term refinancing to pay off the loan over a longer period of time by getting a 25- or 30-year schedule.
Conversely, if you want to build equity more quickly (in the case of a mortgage) or simply pay down your debt faster, you can request a shorter term. It is possible to change from a 15-year loan to a 10-year loan, but keep in mind you will need to pay more each month. Although you will be paying more, a greater amount of each payment will go toward paying off the principal amount, because the quicker you pay off your loan, the less total interest you incur.
For example, if you compare a 30-year loan to a 15-year loan with the same interest rate, you will end up paying more for the 30-year loan based on interest alone. The longer it takes you to pay in full, the more interest you will accumulate - even though your individual payments are lower than the 15-year loan. As a result, many people choose rate and term refinancing in order to adjust their payment schedule to their advantage - regardless of whether the most advantageous choice involves increasing or decreasing the term of the loan.
The Bottom Line
Whether you want to adjust your payment schedule or take advantage of a lower interest rate, rate and term refinancing can be a great way to get the most out of your loan. As mentioned before, situations change from day to day, so a financial decision you made many years ago may no longer be jiving with your current budget or lifestyle.
As is the case with most money-related decisions, it is wise to speak with a financial advisor or your lender to see if rate and term refinancing is the right choice for you.