What is Mortgage Refinancing?
"Refinancing" is the process of renegotiating the terms of your mortgage, either to take advantage of a lower interest rate and minimize your borrowing costs, or to access the equity in your home and turn it into cash.
In effect, you use the new mortgage to pay off the old one, and then repay the new mortgage with improved payment terms.
When to consider refinancing your mortgage
There are several reasons to consider refinancing your mortgage.
1. Obtain a lower interest rate
If interest rates drop lower than the rate you are currently paying, you might be tempted to refinance your mortgage.
Your monthly payment could remain the same, but a higher portion of it would go towards the principal, and a lower portion towards interest. In doing this, you could significantly shorten the length of your mortgage, while increasing the rate at which you build equity in your home.
2. Switch from a fixed rate mortgage to a variable rate mortgage, or vice versa
Variable rates often start out lower than fixed rate mortgages, but adjustments during the term of your mortgage may see them overtake their fixed rate counterparts. If this happens, you might consider switching to the fixed rate. As an added bonus, you would not have to worry about future rate hikes, as your fixed rate would be unaffected.
On the other hand, if interest rates are low and continuing to fall, you may wish to switch from a fixed rate to a variable one. This would eliminate the urge to refinance every time the rates drop, as your interest to principal ratio adjusts automatically.
3. Tap into home equity to finance a large purchase or consolidate debt
Many homeowners struggle to find the available cash to cover occasional expenses, like replacing the roof or repairing flood damage in the basement. These are obviously important projects, and refinancing a mortgage would enable you to access the equity in your home to cover the costs. If the interest rate on the mortgage loan is less than you would pay by using a line of credit or credit card, refinancing might be a sensible financial decision.
If you have several different sources of debt (e.g. credit cards, car loan, tuition fees), it might make sense to consolidate your debt in one place. By tapping into your home equity, and using the cash to clear your existing debts, you will only have to worry about repaying the mortgage lender. Many people find this streamlined approach to debt easier to manage. As an added bonus, if you secure a low interest rate when refinancing, it will cost less than paying off the high interest associated with other debt, like credit cards for example.
Is refinancing always worth it?
If refinancing your mortgage means paying less over time, or having access to more cash, why doesn't everyone do it?
In many cases, refinancing does not make financial sense. Before scheduling an appointment with a lender, it is imperative you do the calculations to make sure you are actually going to save money. If you have a broker, you can ask them for a mortgage analysis to help with this.
What are the expenses associated with refinancing a mortgage?
Lenders and banks will, for the most part, charge you to break the terms of your existing mortgage, and these costs can negate the savings you get from a lower interest rate. The amount you will owe depends on the total amount of your mortgage, and the remaining time left on your current agreement. A quick phone call to your bank or mortgage lender can tell you the exact figure, but refinancing typically costs between three and six percent of a loan's principal.
On top of this, many lenders require you to have at least 20 percent equity in your home before they are willing to refinance your mortgage. If you can't meet this threshold, your mortgage is considered high-ratio and must be insured by the Canada Mortgage and Housing Corporation (CMHC). All lenders charge an additional fee for CMHC insurance. These fees range from 0.5 to 3 percent, depending on the mortgage amount.
Even in a best-case scenario, it will take years to recoup these bank fees with lower interest payments. Speak to your broker and lender, and use a mortgage penalty calculator to ensure the long-term savings outweigh the initial expense.
It is important to remember that when you apply to refinance your mortgage, you have to go through the same process you did for your initial mortgage application. This includes an appraisal of your home, a new title search, and additional application fees.
If it becomes clear that now is not the right time to proceed with refinancing, it is still worth keeping an eye on interest rates. The option to refinance never expires so you can always review the numbers again in the future.
How to qualify for a refinanced mortgage
To qualify for refinancing you must have at least 10 percent equity in your home (some lenders demand 20 percent). To improve your chances of getting approved, find out your credit score, and try to clean up any negative entries. In addition to this, keep any outstanding debt as low as possible. Approval is a lot more likely if you can show the lender a low ratio of debt to income – this is called your total debt services ratio – you should be under 40 percent as a basic rule of thumb.
Ratesupermarket.ca can help you find the best rates
Refinancing a mortgage may seem like a daunting task, and the initial cost associated with terminating your current agreement is enough to put many people off. However, if you do your due diligence it can be a great way to save money, and a fast track to becoming mortgage free! Ratesupermarket.ca is the best place to find and compare mortgage rates. We'll help you find the best deal!