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How To Refinance Your Mortgage

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Do you have debt with a high interest rate (anything above 5% is considered high these days)? Do you plan to make a costly investment or do a home reno but lack the capital to get started? Are you stuck under a home mortgage interest rate that’s double what banks are currently offering?

If you answered yes to any or all of these questions, then it might be time to refinance your mortgage.

Refinancing your mortgage can be an effective tool to accomplish a few specific financial goals. It’s an option that every Canadian home buyer should understand. Keep reading to find out more.

What is refinancing a mortgage?

Refinancing your mortgage means paying off one mortgage and replacing it with another. Simple enough so far.

The dollar value, interest rate, and amortization period (number of years until the mortgage is paid in full) can all change from how your previous mortgage was set up. All of those factors will depend on your own financial health and the reason you refinanced your mortgage in the first place.

Why should you refinance a mortgage?

It’s important to know that refinancing your mortgage is not for every home buyer. There are fees and charges, credit history checks, waiting periods, meetings, appraisals, and legal documents involved in this process. So, don’t jump into this decision without doing your research, you won’t regret it.

Refinancing might be right for you if…

1. You want to access cash for an investment, home renovation, or to pay down debts (consolidate).

Inflation rates are up and wages are stagnant. Fortunately, you have your mortgage. It’s not a financial drain, it’s an opportunity.Most banks and lenders will refinance up to 80% of the value of your home. So, if your home is appraised at $400,000, your bank will give you up to $320,000 for your new mortgage. Let’s say you’ve already paid $120,000 against your mortgage, leaving it at $280,000. That leaves you with $40,000, not bad!Here’s how the math looks:Current mortgage amount $280,000
Appraised value of home $400,000
Refinance amount (80% of appraised value) $320,000

$400,000 (appraised value of home) x 80% (max refinance amount) =$320,000

$320,000 (Refinance amount or New mortgage amount) – $280,000 (Current mortgage) = $40,000 (cash in your pocket).

That $40K could go towards RRSP’s, home renovations, a down payment on a rental property, your child’s education fund, whatever. It’s yours to use as you want.

This example would require you to break your mortgage to get another one, and that includes a fee called a prepayment penalty. The prepayment penalty is a charge your lender can levy against you for breaking your mortgage early. It’s typically equal to around three months of interest charges.

However, you can access money from your home in a way that doesn’t break your mortgage using a Home Equity Line of Credit (HELOC).

A HELOC is like borrowing back the money you’ve already paid against your mortgage from the bank. You’re accessing a portion of the equity you’ve built up in your home as cash withdrawals. There are some big positives to this strategy, namely, it isn’t a single lump of money like a standard mortgage refinance. Instead, you only borrow what you want. The downside of a HELOC is the monthly payment structure which is only calculated to pay down the interest on your equity withdrawals. In that way, a HELOC is similar to a credit card and requires the same financial discipline to pay more than the just the minimum amount.

Also, it’s important to know that if you plan to switch mortgage lenders you will have to pay off your HELOC entirely before you make the swap.

2. You want to change your old mortgage rate for a new, lower mortgage rate.

Did you sign up for your mortgage at a higher rate compared to what’s being offered now by other mortgage lenders and banks? You might save a lot of money over the life of your mortgage by refinancing for a lower rate. There are a couple options available to you.

Break your Existing Mortgage

This is the same method as outlined in the first example above. You can get some money AND a lower mortgage rate out of a total refinance. If interest rates have dropped since you signed your mortgage, you can potentially save thousands of dollars by refinancing, even considering the costs for breaking your mortgage.

Say your remaining mortgage is $300,000 at a 2.5% interest rate. Over a five-year term, you’ll pay $37,500 in interest.

But, maybe the interest rates have changed dramatically. Let’s say your bank is now offering 1.9% interest for mortgages. A mortgage of $300,000 at 1.9% interest over five years will only cost $28,500 in interest.

Let’s compare:

$37,500 – $28,500 = $9,000

If all the fees charged by your bank are less than $9,000, then you know you’ll save money with the new interest rate. However, if the fees are only slightly lower or equal to $9,000, it might not be worth the effort or the stress to change things.

Blend-and-Extend

This option is sort of a compromise between you and your mortgage lender. It allows you to get a lower mortgage rate, avoid expensive fees for breaking your mortgage early, and it allows your bank to keep your business while salvaging some money by offering you a financing rate that isn’t the absolute rock-bottom.

There is a formula to determine what rate you will be offered by your bank if you opt for a blend-and-extend mortgage. The formula basically amalgamates your current interest rate and the amount of time left in your current term with the low interest rate and a new mortgage term–usually five years–to determine a rough middle ground financing rate which the bank can offer you.

There may be some wiggle room in the formula based on your bank and if you’ve been a long-time customer of theirs.

*Hint: It’s much, much cheaper for your bank to keep your business than it is for them to attract new a customer*

When can you refinance a mortgage?

You can refinance your mortgage at any time. But should you?

There is a bad time to refinance and a good time.

A bad time to refinance your mortgage would be right at the beginning of a term, and close to the time when you purchased your home or property–before you have earned much of any equity.

A good time to refinance is basically the opposite, at the end of your term and after you’ve paid down your mortgage amount thus creating a large amount of equity for yourself.

The reason for this is simple: the bank will charge you much less to refinance and break your mortgage at the end of your term than at the beginning because they’ve been making money on your mortgage for the length of your term.

If you broke your mortgage at the beginning of your mortgage term, the bank would have to extract their pound of flesh to make sure they aren’t losing money.

So, if you’re planning to refinance your mortgage, wait as long as you can. Try to wait until the interest rates and the end of your term align to give you the best deal on your new mortgage.

That said, you might have some external pressure that requires you to refinance at a time that is less than ideal. Talk to your bank about this and see if they have a creative solution which they can offer you. Remember, banks want to keep your business, so they SHOULD be highly motivated to come up with a strategy that meets your needs and keeps your money in their institution. That’s not cynicism, that’s interdependent real life.

Pros & Cons of Refinancing yout Mortgage

To summarize the information so far, here’s a tl;dr list to help simplify the subject of mortgage refinancing:

Pros

  • A lower interest rate can save you a lot of money over the duration of your mortgage.
  • Gain access to the equity you’ve accumulated
  • Pay off high-interest debt and consolidate all debts under one loan

Cons

  • The cost to break your mortgage might actually be higher than what you’d save..
  • Accessing equity increases your mortgage debt
  • It will take you more time to pay off the mortgage than it would have taken you to pay off other loans.

Before Refinancing your Mortgage

t the cost before committing to refinancing your mortgage. There are several things to consider, such as the fees your bank will charge you, how this decision will affect your credit score, and is a lump sum of cash now worth starting to pay your mortgage down from scratch?

Refinancing Costs

Remember that refinancing your mortgage can be very expensive and that may outweigh the benefits you hope to achieve. Be very, very sure that refinancing will be a net gain for you both financially and psychologically. If a high-interest debt is crushing you every month, then you may accept a less favourable mortgage refinancing just to get that monkey off your back.

Credit Score

Refinancing your mortgage requires a “hard check” on your credit history which will negatively impact your credit score, But it’s not all bad. This decrease is usually temporary, and there are ways to avoid making your credit score drop even more and affect available interest rates for loans.

Try to avoid taking out other loans right before or right after you refinance your mortgage. The multiple credit history checks can alter the interest rates you might otherwise receive and cost you money, potentially a lot of money.

How to Refinance your Mortgage

If you haven’t figured it out yet, refinancing your mortgage is a big deal; it’s a decision with long-term consequences. Here is a breakdown of the steps to refinance your mortgage to help guide you in the process.

1. Is it necessary?

Look at your financial situation and your plan for the next 5 to 10 years. Do you need this loan? Do you need to access your home equity? Can you achieve your goals without refinancing your mortgage? If so, how?

2. Carry the one

Figure out exactly how much refinancing will cost you in dollars and in time. Can you afford the new monthly payments? Can you afford the fees the bank will charge you just to accomplish the refinancing?

3. Research

Look around for the lowest interest rate currently being offered on mortgages. Determine whether your credit score can handle the refinancing application’s “hard check”. Is refinancing the best decision? Could you open a HELOC instead and avoid breaking your current mortgage?

4. Apply

Submit your application for refinancing knowing what to expect. All refinancing requires an appraisal, what if the appraisal of your home comes back less than you’d hoped?

5. Approval and Review

Your application has been accepted, but should you accept the terms you’re being offered? Never sign something without fully understanding it. Ask questions.

The Bottom Line

Refinancing your mortgage can be a fantastic decision which leaves you with a lower interest rate and some spare cheddar. Your home can be an asset if you make it work for you, and refinancing is one of the most potent tools available to accomplish that.

Should you refinance your mortgage? Do your research, know the math, then you can answer that question for yourself. With better information, you can make better decisions.

Frequently Asked Questions

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