Should I Refinance My Mortgage?

Refinancing your mortgage can be a confusing process. This quick guide will help you through it.

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What is mortgage refinancing?

Mortgage refinancing is the act of paying off an existing mortgage with a brand new one. Homeowners do this to take advantage of a lower interest rate, consolidate debt, change mortgage types, or access the equity in their home.

You can refinance as long as you have at least 20 percent equity in your home (though some high-cost, non-prime lenders permit exceptions to this). If done carefully, refinancing can save you thousands of dollars over the course of your mortgage. If you keep the same monthly payment schedule, a lower interest rate means a larger portion of each payment is applied to the principal. This not only saves you money, but potentially shaves years off the amortization period.

Refinancing to tap into the equity of your home makes sense if you need the cash for a critical expense, or you have high-interest debt, and can pay it off with a low-interest loan from your mortgage lender. It is not a smart financial decision to refinance your mortgage for a frivolous expense like going on a shopping spree!

Before you call your mortgage provider to discuss your options, it is important to remember that lenders will charge you to end your current mortgage term early. Even if you refinance with a lower interest rate, there is no guarantee that the long-term savings will outweigh the initial expense. Use a mortgage penalty calculator to determine possible costs, and if the numbers make sense, contact your lender to discuss the specifics.

Reasons to consider refinancing your mortgage

1) Take advantage of a lower interest rate

Suppose you are three years into a 5-year fixed term mortgage and interest rates have plunged since you first got your mortgage. New homebuyers will be paying a much lower rate for the same term that you did.

A lower interest rate helps pay off loan principal faster, building your equity quicker and ultimately reducing the length of your mortgage.

That begs the question: Should you honour your initial mortgage obligation and pay the higher rate for another two years, or take advantage of the lower rate by refinancing now?

While the urge to refinance immediately is understandable, doing so prior to your mortgage renewal often results in a penalty. Penalties range from as little as three months’ interest to well into five-figure penalties. Your decision hinges on whether the savings from the lower rate outweighs the penalty and closing costs you’ll incur. Penalties vary across institutions and depend on the mortgage type (fixed vs. variable), term length and your existing rate, among other things.

Tip: If you want to refinance your mortgage and take advantage of a lower rate, first use our Mortgage Penalty Calculator to get a rough idea of your prepayment charge. Note: Always verify the exact amount with your lender as lenders’ penalty formulas can differ.

2) Consolidate your current debts

If you're struggling with high interest debt (e.g. credit cards or personal loans) and have enough equity in your home, refinancing your mortgage is a potential solution.

Through refinancing, you can pay off your existing mortgage with a larger one, and use the remaining cash to consolidate your debts at a lower rate of interest. This helps pay off your debt quicker and can lower your monthly payments. Another plus is that one monthly payment is always easier to manage than multiple payments to different creditors.

Tip: Thinking of refinancing your mortgage to consolidate your debts? Use our Debt Consolidation Calculator to estimate the savings of consolidation and a lower interest rate, after factoring in the mortgage penalty.

3) Access equity in your home

If you need to renovate your home, take care of unforeseen medical expenses, pay for post-secondary education or just require immediate cash, refinancing can be the solution. You can pull out equity from your home by refinancing through a new mortgage or a Home Equity Line of Credit (HELOC). This is generally a more attractive option than financing with a high-cost credit card or unsecured line of credit.

As with the aforementioned scenarios, refinancing a closed mortgage prior to maturity would likely result in a pre-payment penalty.

Money saving tips for refinancing

If you are refinancing, either to consolidate your debt or access equity in your home, your lender may offer a 'blend and extend' option. That enables you to avoid an out-of-pocket penalty for breaking your existing mortgage early. Any additional borrowed money gets added to your existing mortgage, with the rate being a weighted average of the existing rate and the new rate.

Tip: Some lenders roll the penalty into your new rate and some don’t. Be aware of this and confirm your lender’s policy.

If you have a broker, ask them for a mortgage analysis to help with the refinancing decision. Their understanding of your financial situation, coupled with their knowledge of current market rates and mortgage math, will confirm if there’s a net benefit.

Other things to consider when refinancing a mortgage

Approval for refinancing is not guaranteed and the outcome is not always favourable. Getting new financing involves a reappraisal of your home, a new title search and additional fees (legal fees and discharge fees, for example). If your home value has gone down since you first got a mortgage, you may not have enough equity to refinance.

If you can show the lender you have a low debt-to-income ratio, your chances of approval will improve. To be approved at the best interest rates, you need a total debt service (TDS) ratio under 40 to 44 percent. That is, your mortgage payment, monthly property taxes, heating costs and any debt payments must be less than 40 percent of your provable gross monthly income.

If you have less than 20 percent equity in your home, your mortgage is considered “high-ratio” and must generally be insured by the Canada Mortgage and Housing Corporation (CMHC) or a private insurer. You cannot refinance with an insured mortgage.

While refinancing might seem daunting at first, it can save you a lot of money. RATESDOTCA can help you find the most competitive mortgage rates in Canada. While you’re at it, check out our free calculators and mortgage guides for additional tips.

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