Of all the borrowing options available to Canadians, those that are secured by your home are often the most popular. This is because they typically offer the lowest interest rates available. They can also spread repayment over a longer period than other loans.
A mortgage, a home equity line of credit and a home equity loan all offer interest rates that are usually considerably lower than what you’d get with credit cards or personal loans. A mortgage refinance is a way to tap into the equity in your home to provide a low-cost loan option.
Let’s take a look at how a mortgage refinance works, how you can go about it, its pros and cons, and whether it’s a good choice for you.
What does a mortgage refinance mean?
A mortgage refinance is when you take out a new mortgage with different terms; these could include the amount borrowed, the interest rate and the amortization period.
People often refinance their mortgage to access the equity that has built up in their home, by increasing the amount of money that they owe on the mortgage. However, they sometimes refinance if interest rates drop, or they need to lower their monthly payments by extending the amortization period.
How does a mortgage refinance work?
Canadian homeowners sign up for a specific term when they take out a mortgage (the most popular one being five years), but you can also sign up for between one and seven years, or even longer. A mortgage refinance can happen either during the term (which would involve breaking the mortgage and potentially paying a penalty to do so) or at the end of the term (when no penalty would be involved).
If you refinance at the end of your mortgage term, you could ask to increase the amount of money on your mortgage or extend/shorten the amortization period (this is the length of time it will take to pay off the mortgage completely). You can also negotiate a better interest rate (which can also happen when you renew your mortgage after the term has ended; this is when all other conditions on the mortgage remain the same).
What is a cash-out refinance?
A cash-out mortgage refinance is when you increase the amount of money on your mortgage and take the extra money in the form of a lump sum. This is a great way to access the equity in your home, but you would need to have built up enough equity to do this. Equity is the value of your home minus money owed on it (which includes the mortgage, home equity line of credit and home equity loan).
Financial institutions will lend up to 80% of your home’s value with a mortgage refinance. Here’s an example:
Julienne and Robert’s home is worth $800,000.
Their mortgage is $420,000.
Their home equity is $380,000.
They could, in principle, borrow up to an extra $220,000.
(80% of $800,000 = $640,000 - $420,000 = $220,000)
However, Julienne and Robert would also need to qualify for the extra amount of money on their mortgage refinance. The bank would analyze their income, debts and other outgoings to create debt service ratios. If the calculations come in under the debt service ratio maximum limits, then they may then qualify for the mortgage refinance (other criteria, such as their credit scores, would also be taken into account).
Mortgage affordability calculators like this one can help you work out how much of a mortgage refinance you could qualify for.
Why would you refinance your mortgage?
These are the most popular reasons why Canadians decide on a mortgage refinance:
To free up equity: many Canadian homeowners cash in some of the equity in their home to use as a low-interest loan. This in turn can be used for several purposes, including to:
- Consolidate debt by using the equity to pay off high-interest debts, such as credit card balances, vehicle payments and personal loans. This has the advantages of simplifying and lowering monthly debt payments, as well as reducing overall interest paid.
- Make large purchases, such as to buy a new car, pay for a wedding or cover education expenses.
- Pay for home renovations, which can increase the value of your property.
To secure a lower interest rate: a lower rate can significantly reduce the total interest paid over the life of the mortgage.
To lower monthly payments: using a mortgage refinance to get a lower interest rate or a longer amortization period can reduce monthly payments considerably. This can free up more income to improve cash flow and increase the amount of money you can save.
How to refinance your mortgage
Firstly, you’ll need to decide on why you would want a mortgage refinance. Are you looking for a better rate or to cash in some equity? Do you want to reduce your monthly payments by extending the amortization period?
You may decide to refinance your mortgage with your current financial institution, or shop around for one that might be offering better interest rates. You’ll also need to determine whether you’ll qualify for the mortgage refinance that you have in mind. Typically, going with a lender who is offering lower interest rates or extending your amortization period are usually straightforward (though reducing your amortization period could be trickier).
Cashing in some of your home’s equity by increasing the size of your mortgage is more complicated. You’ll typically need to:
- Qualify, using the lender’s debt service ratios based on the new monthly payments.
- Provide proof of income and details of debts.
- Have an appraisal on your home so the lender knows its market value and therefore the amount of equity you can borrow.
- Get a lawyer involved to finalize the mortgage refinance.
- Pay any prepayment penalties if you break your mortgage.
Also, if the mortgage refinance is for debt consolidation, the lender may want to pay off your current debts directly.
The pros and cons of a mortgage refinance
A mortgage refinance can be a powerful tool that can boost your financial plan, save you money in interest, improve your cash flow and help you to put more money into savings. However, it’s not for everyone, and there can be some downsides. These pros and cons can help you work out if a mortgage refinance is a good option for your situation.
Pros:
- You could get a lower interest rate, reducing the total interest paid over the life of your mortgage.
- Lower monthly payments can improve your cash flow and reduce financial stress.
- You can free up equity to pay off debts, fund large purchases or finance home improvements.
- You can shorten or lengthen the amortization period, to either pay off your mortgage faster or have more affordable mortgage payments.
Cons:
- You might have to pay prepayment penalties if you break your existing mortgage.
- Closing costs may be involved, which can include appraisal fees and legal fees.
- Refinancing to a longer amortization period could result in paying more interest over the life of the loan, even if the interest rate is lower.
- A larger loan will usually mean higher monthly mortgage payments.
- If you're unable to make your mortgage payments, you could lose your home.
Which is better: a mortgage refinance, a HELOC or a home equity loan?
Lending options that are secured on your home — including a mortgage refinance, a home equity line of credit (HELOC) and a home equity loan — all share the key advantage of low interest rates.
They all have pros and cons, and the best choice will depend on your circumstances and what you need from a loan.
A mortgage refinance allows you to cash in some of the equity in your home at a low interest rate compared to other unsecured loans. Payments are blended into your overall mortgage payments, making them affordable. You can also extend the amortization period to make mortgage payments more affordable.
A mortgage refinance can be a good option if you need to make a large purchase, cover big expenses or pay off high-interest debt.
The main disadvantages are that you could owe more money on your mortgage, it could take longer to pay off, and you could end up paying more in interest.
A home equity line of credit (HELOC) is a very flexible way of tapping into your home equity. Once approved, you can take out as much or as little of the approved limit, for any reason. As you pay back what you owe, that amount becomes available to borrow again. You only pay interest on what you’ve borrowed.
There is no structured repayment period, as there is with a mortgage refinance, though you do have to pay at least the monthly interest. While this allows for more flexibility, it can mean that it will take longer to pay the loan off.
Interest rates are not as low as with a mortgage refinance, but they are still considerably lower than most other borrowing options. A HELOC is great if you know you’ll need money at various times in the future and want the flexibility to pay it off at your leisure.
When can you refinance a mortgage?
You can usually request a mortgage refinance at any time, however, if you’re looking to increase the amount of the mortgage, you’ll need to have grown enough equity to do so.
Ideally, you would want to time your mortgage refinance for when your mortgage term is coming up and it’s time to renew it. That way, you can make changes to your mortgage without having to pay a prepayment penalty. This can be thousands of dollars, depending on the type and amount of your mortgage.
Is a mortgage refinance right for you?
Making the decision of the best loan for you shouldn’t be made alone. Your IG Advisor can recommend the best home-secured loan for your circumstances, whether that’s a mortgage refinance, a HELOC or a home equity loan.
They’ll also be able to devise a mortgage strategy for you that will complement your financial plan and help you reach your financial goals faster. Talk to your IG Advisor about whether a mortgage refinance is the right option for you. If you don’t have an IG Advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Advisor.
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