Similar to words such as ‘pataphysics’ (the science of imaginary solutions) or ‘vernorexia’ (a romantic mood inspired by Spring), the definition of ‘refinance’ is just as misunderstood.
And when it comes to refinancing your mortgage versus renewing your mortgage - well that tends to make things even more complicated (like they weren’t complicated enough already!).
Refinancing is the process of paying off your existing mortgage and any outstanding claims against your home by setting up a new mortgage. Basically, you pay off your old mortgage with a new mortgage.
This reason for refinancing has become more and more common over the past few years given that interest rates are at record lows. It may make sense for you to break your existing mortgage agreement to get a much lower rate. The penalty to break your mortgage will depend on a number of factors, but a charge of a few thousand dollars now in exchange for moving to a rate that’s 1-2% lower, may be worth it.
One of the ways you can use refinancing to improve your financial situation is to take out the equity in your home and purchase other investments or swap your debt to transfer non tax deductible debt into deductible debt.
This is obviously quite complicated, but a good financial planner or mortgage broker will be able to help you. If this is done properly you can benefit by reducing your monthly payments or make some of your mortgage interest payments tax deductible, sometimes resulting in tax cuts of almost 50% for high income earners.
If you have a number of different outstanding debts, such as a car loan, a line of credit and credit card bills, it may make sense for you to consolidate all of the debt into one loan or access your equity to pay off the debt.
How would this work? Let’s say you owe $20,000 on your credit card, your property is worth $200,000 and your mortgage is $120,000 (60% LTV). You have $80,000 of equity in your home. You could take out some of your equity, pay off your credit card bill and then refinance your mortgage for $140,000 at a rate that will be much lower that what your credit card provider was charging.