Clay Jarvis
Beth Buczynski
A mortgage refinance involves breaking your existing mortgage contract and paying the current balance in full by securing another mortgage loan. This new loan comes with its own terms and conditions, including a different interest rate than you had with the prior mortgage loan.
Refinancing can be a beneficial move if it’s timed well and done carefully. It pays — quite literally — to know all you can about the process before deciding whether a mortgage refinance is right for you.
How refinancing a mortgage works
Because refinancing requires a new home loan, the process is similar to applying for a mortgage.
You’ll have to schedule a home appraisal to determine your property’s current value. Your income, debt service ratios and credit history will all be evaluated, so expect to provide much of the same information that you were asked for when you got your first mortgage. This can include:
- Identification.
- Proof of employment and income.
- Details regarding your assets, savings and debts.
- Tax documents.
You’ll also have to pass another mortgage stress test to determine your ability to repay your refinanced mortgage in the event that interest rates increase. The rate you’ll be stress tested at, also known as the minimum qualifying rate, will either be 5.25% or the rate your lender is currently offering plus 2%, whichever is higher.
When refinancing, it’s important to do some comparison shopping to ensure you’re getting the best rate, terms, service and conditions. You don’t have to refinance your mortgage with your current lender, so it’s best to compare several before deciding which one presents the best deal.
And if you do stick with your lender for your refinance, don’t be afraid to negotiate a better mortgage contract.
Reasons to refinance a mortgage
There are two main reasons why you might want to refinance your mortgage.
1. To secure lower borrowing costs
Refinancing can be a way to secure a lower mortgage interest rate, a longer amortization period or new conditions that might allow you to repay more of your mortgage ahead of schedule. Each of these changes can lead to lower short- and long-term mortgage costs.
When refinancing to get more attractive loan terms, you don’t necessarily have to pull out any of your equity.
2. To free up cash.
A refinance also gives you the option of accessing any money left over after paying off your previous mortgage. This could be tens, or even hundreds of thousands of dollars, depending on the value of your home and how much equity you have.
Because this cash will cost you in interest charges, it’s best to use it to pay for things that provide or appreciate in value, like:
- Home renovations.
- An investment property.
- A child’s education.
- Starting a small business.
- Debt consolidation.
But it’s your equity. There’s nothing stopping you from using it to pay for a vacation, a new boat or something else on your wish list. Just make sure there aren’t any cheaper, easier ways of paying for these items before moving forward with a mortgage refinance.
How much can you borrow?
A mortgage refinance is often a way for homeowners to access additional cash. The amount you can borrow using your new mortgage is determined by how much home equity you have.
You can typically borrow up to 80% of the appraised value of your home when refinancing, but you’ll have to use a portion of what you borrow to pay off any amount remaining on your current mortgage. What’s left over can be spent however you like.
If your home is worth $500,000, for example, you could borrow up to $400,000 ($500,000 x 0.8) when refinancing. But if your current mortgage balance is $350,000, you would really only have access to the $50,000 left over after paying off your mortgage ($400,000 – $350,000).
The cost of a mortgage refinance
If you’re considering a mortgage refinance, be sure to budget for all the possible costs involved. A refinance might require paying:
- Legal fees.
- Title search and title insurance fees.
- Home appraisal fees.
- Mortgage discharge fees (if you change lenders).
When you add in prepayment penalties, a refinance could cost you thousands of dollars in upfront charges, not to mention the interest you’ll pay. Understanding the full cost of a refinance can help you accurately compare it to other financing solutions, like a tp home equity line of credit (HELOC) or home equity loan.
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When to refinance your mortgage
Because you’ll be paying off your mortgage early, your lender may charge a prepayment penalty to refinance. To minimize this penalty, the ideal time to refinance is generally near the end of your mortgage term, especially if you have a closed, fixed-rate mortgage.
If you refinance a closed mortgage ahead of schedule, your prepayment penalty will likely be based on your lender’s interest rate differential (IRD), a calculation that helps them recoup some of the interest they’ll be missing out on. IRD varies from lender to lender, but it typically results in higher penalties than those charged on open or variable-rate mortgages.
The penalty on a variable-rate mortgage isn’t as steep. It’s typically three months’ interest.
When deciding whether to refinance your mortgage mid-term, it really comes down to whether the benefits outweigh the costs. To determine if the time is right to refi, ask yourself (and your lender) the following questions:
- What’s my existing mortgage rate versus current mortgage refinance rates?
- What are the legal and closing costs (e.g., appraisal, title search, and title insurance fees) associated with refinancing this mortgage?
- Am I consolidating high-interest debt?
- How much is the penalty cost (if any) for breaking my mortgage?
- Would refinancing improve my lifestyle?
Is refinancing your mortgage a good idea?
Mortgage refinancing is how many Canadians tap into their home equity. When done thoughtfully, refinancing can ease your debt burden or increase your wealth.
Refinancing can be particularly useful if you have a variable-rate mortgage and rates have increased significantly over your term. In this case, refinancing might allow you to switch to a fixed-rate mortgage and secure a lower, more stable rate without penalty.
But there are instances where refinancing may not be the best move. If prepayment penalties will devour a significant portion of the proceeds, for example, you might be better off waiting until the end of your term and seeking out a better deal when you renew your mortgage.
If you refinance to extend your amortization period, you may secure lower payments, but you’ll be paying interest for several additional years and adding thousands of dollars to the cost of your mortgage.
Pros and cons of refinancing a mortgage
Pros:
- Saving money by getting a lower interest rate.
- Freeing up cash flow by arranging smaller monthly mortgage payments.
- Accessing funds that can be used on major purchases or debt consolidation.
Cons:
- Winding up with a longer mortgage.
- Having to pay penalties or other fees.
- Paying a higher interest rate than if you waited to renew.
Alternatives to mortgage refinancing
If the costs or complexities of refinancing don’t seem like a fit, there are other options to consider.
Blend and extend
Some lenders allow you to renegotiate your interest rate before the end of your mortgage term through a blend-and-extend option. This allows you to extend your existing mortgage term at a lower rate by blending a new, lower interest rate with the previous one while avoiding prepayment fees.
Home equity line of credit
If you have at least 20% equity in your home, you can borrow against it using a HELOC. The maximum credit limit will be 65% of your home’s market value.
You can get a HELOC in addition to your existing mortgage, so you won’t have to break your mortgage or pay prepayment penalties. HELOC interest rates will typically be higher than a mortgage refinance.
Home equity loan
A home equity loan is another way to turn equity into cash. A home equity loan is issued on top of your primary mortgage, typically by a non-chartered bank or private lender. You’ll avoid prepayment penalties, but will have to pay whatever fees your new lender charges. Interest rates on home equity loans can be much higher than those charged on a mortgage refinance or HELOC.
Frequently asked questions about mortgage refinance
There are no limits on the number of times you can refinance a mortgage in Canada. But each refinance, depending on when you apply, could cost you in administration fees or penalties. And if your amortization period gets extended with each refi, you could be paying additional interest for years.
A mortgage refinance can negatively impact your credit. By closing your previous mortgage and replacing it with a new one, you may reduce the overall length of your credit history, which can impact your credit score. Any hard inquiries into your credit report made during the refinancing process can also temporarily lower your credit score.
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