Refinancing a Mortgage in Canada Amid the COVID-19 Crisis

Young couple looking intently at computer with note paper in front of them

With ongoing economic uncertainty, temporary layoffs and substantial job losses, many Canadians are working to find flexible solutions to manage financial hardships.

Recent figures from the federal government show more than six million people are receiving the Canada Emergency Response Benefit, with nearly a million more applications in limbo. The Canadian Bankers Association also reported that nearly 600,000 customers are now deferring mortgage payments, proving the financial ramifications to be far-reaching.

According to a survey conducted by Leger, 44% of respondents feel the current COVID-19 crisis has negatively impacted their income.

Highlights of the study:

  • Fifty-four percent of respondents say the pandemic is hurting their retirement savings and investments.
  • Twenty-six percent of those surveyed worry they will not be able to pay their bills on time.
  • Twenty-one percent of respondents will have difficulty paying their mortgage or rent.

Lenders are seeing an increase in borrowing with thousands of Canadians extending their credit limits and hurrying to refinance their mortgages to ease financial burdens or provide an essential safety net.

Mortgage Refinancing

According to a recent study by our friends at Rates.ca, “People generally refinance for similar reasons, the most popular being switching to a lower rate (34%), moving to a new home (25%) and taking out equity (14%).”

As a result of the coronavirus outbreak, many mortgage holders are opting to refinance to give themselves more financial wiggle room. Borrowers are choosing to:

  • Secure a lower rate
  • Lower their payments and extend their term
  • Add a home equity line of credit (HELOC)
  • Consolidate high-interest debt
  • Pull out equity ahead of potential job loss or property value reductions.

However, in these abnormal times, there are a few extra details you will need to consider before contacting your lender.

Stringent Employment Verification

Lenders are required to obtain employment verification to process mortgage applications. As many Canadians now find themselves temporarily laid off or without work, they may no longer qualify for the loan. Additionally, those who have been fortunate enough to work from home or have a job that has been deemed essential may find it difficult to prove job security.

Application Process and Timeframe

Banks are working in overdrive to manage urgent requests and immediate matters relating to financial hardships from the COVID-19 crisis. Although financial institutions are still offering a full range of products, refinances may be a lower priority behind purchases and lender switches. Under current circumstances, it could take upwards of 40-plus days to close a refinance, considering the high demand, lending, appraisal and signing constraints.

If you are looking for a quick infusion of cash, you may be looking in the wrong direction.

Mortgage Penalties and Additional Costs

Breaking an existing closed mortgage to refinance will result in penalties. Mortgage penalties are the lenders’ way of compensating for lost revenue. So, you will need to calculate and factor in these costs.

For variable-rate mortgages, penalties amount to a total of three months’ interest on your loan.

For fixed-rate mortgages, the math is not as straightforward. Penalties are calculated using the interest rate differential (IRD) or three months’ worth of interest, whichever is greater. This figure can vary depending on your mortgage contract and your lender. Lenders can use the posted rate or a discounted rate, which can result in higher penalties for fixed-rate mortgages.

Start by consulting your mortgage contract and review how your lender will determine your mortgage penalty. You can calculate possible prepayment penalty costs by using RateSupermarket.ca’s mortgage penalty calculator. Keep in mind, for a refinance to be beneficial, the costs can’t outweigh the potential savings.

Additional Costs

Apart from mortgage penalties, you should also factor in costs associated with a title search, title insurance, home appraisal and legal fees.

Interest Savings

As mentioned previously, refinancing into a cheaper rate will only be beneficial if you end up with savings after the mortgage penalties and administrative costs. Here is how to calculate your potential savings:

  1. Calculate the interest you would be paying at your current rate over your remaining term (if you have two years left on a 5-year term, your remaining term is two years).
  2. Next, calculate the interest you would be paying for your mortgage, with a lower mortgage rate over the same term. You can determine how much interest you would be paying with a mortgage payment calculator.
  3. Take your figure from step one and subtract the figure you got from step two to calculate your savings.
  4. From that total, subtract your mortgage penalty and refinancing costs (expect $1,000 or more), to see if you come out ahead.
  5. If you are consolidating high-interest debt into your new mortgage, calculate the interest savings over your new term (step 2).

How to Find the Best Rate

Although existing variable-rate borrowers have seen their rates drop since the Bank of Canada rate cut in March, new shoppers saw mortgage rates increase in the following weeks. Lenders reduced their discounts from the prime rate, and in some cases, added premiums to prime for new customers to compensate for greater risk and decreased liquidity in the market.

Historically these risk premiums are temporary measures, and that appears to have been the case this time around too, as we’ve already seen a reduction or removal of those premiums. So, don’t overpay for a 5-year fixed or variable rate. Compare mortgage rates and consider a cheap, shorter-term mortgage, if it matches your risk tolerance and your finances can support it.

Home Equity Line of Credit (HELOC)

A HELOC can be a valuable source of funds if your income is interrupted or you face a financial emergency. A HELOC is an amount of credit that is secured against your home.

To qualify for a HELCO, you must have:

  • Homeownership
  • A credit score between 650-900
  • Verified and sufficient employment or income
  • A least 20% equity in your home

A HELOC works much like a regular line of credit, allowing you to access funds as you like, up to the limit. You can even pay it back and borrow the funds again. The interest rate is variable and accrues only on the funds that you withdraw. Plus, payments are interest-only.

HELOC Rates

Currently, rates are below 3%, which is far better than the standard 19.99% interest rate charged on a credit card. However, as the demand and credit delinquencies increase, rates will surely follow.

Additionally, HELOCs can’t be acquired overnight and getting approved requires excellent credit, among other strict conditions.

Comparison of HELOC and Refinancing Requirements

Product Characteristics Refinance HELOC
Equity Required 20% 20%
Equity Accessible 80% Up to 80% of home value
Interest Rate Fixed or variable rate Variable rate
Fees Mortgage prepayment penalties, as well as administrative costs such as appraisal and legal fees No extra fees

Volatile Loan-to-Value Ratios

A loan-to-value (LTVs) ratio is an assessment of the loan amount compared to the appraised value. Lenders use these figures to determine lending risk. If a borrower has a high LTV, they may be required to purchase mortgage insurance, making the loan cost more.

To calculate your LTV, divide the mortgage amount by the appraised property value or total purchase price of the home. For example, if the purchase price of your home is $450,000, and you have a mortgage of $360,000 (after a down payment of $90,000), your LTV ratio is 80%.

Appraised Property Value Down Payment Mortgage Amount Loan-to-value Ratio
$450,000 25% ($112, 500) $337,500 75%
$450,000 20% ($90,000) $360,000 80%
$450,000 15% ($67,500) $382,500 85%
$450,000 10% ($45,000) $405,000 90%

Lenders typically offer more ideal rates to borrowers with LTV ratios of 80% or lower. However, financial institutions are being more vigilant and lowering their maximum LTV below the standard 80%, in some circumstances, to 75%. With the current economic climate, your home value may also come in lower than expected as appraisers and lenders err on the side of caution.

Falling property values, your credit score, and employment status can affect your ability to refinance. That’s why experts recommend you apply for a refinance before you need one.

Related Topics

Mortgages / Refinancing and Renewing

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