Considering a mortgage refinance? Refinancing can save you a lot of money, but it doesn’t always make sense.

Here we take a closer look at the ins and outs of refinancing.

What Is a Mortgage Refinance?

Refinancing is when you change key terms of your mortgage but don’t change the property. That can mean borrowing more money, adding or removing someone from title and/or extending the amortization to lower your payments.

The most common refinance is to borrow more money. That’s based largely on how much equity you have.

To figure that out, simply take your home’s current estimated market value (how much it would sell for today, conservatively speaking) and subtract the outstanding mortgage balance.

If your home is worth $800,000 and your outstanding mortgage balance is $500,000, for example, you will have $300,000 of home equity.

When you refinance your home, you may be able to borrow up to 80% of your home’s current lending value, provided you qualify. Among other things, you must have enough income to pass the mortgage stress test. More on that later.

When Should You Consider Refinancing Your Mortgage?

There are cases where refinancing a mortgage makes clear sense.

To save on interest. One reason is to lower your interest bill each month. You might have locked in when rates were high, and now rates are much lower. By refinancing your mortgage, you can reset to a lower rate, assuming the savings outweigh the costs. (I will discuss that in the next section.)

Access equity in your property. If you’ve been paying down your mortgage like clockwork over the years and your property has gone up in value, you may have a significant amount of equity. That equity can be used for investing, funding education, starting a business, buying a cottage, you name it.

Consolidate debt. If you have high-interest debt, you might consider consolidating it with your mortgage. Since mortgage debt is generally the cheapest debt out there (a lot less than 20% interest rates on credit cards), your interest savings can be substantial. Consolidating debt can get you to a positive net worth faster. Just make sure you don’t rack up the cards again once they’re paid off (a common mistake).

Tip: If you’re consolidating debt via a Home Equity Line of Credit (HELOC), there’s a risk that you won’t pay down your debt as aggressively since HELOCs have interest-only minimum payments. That mistake can keep people on their creditors’ debt rolls for years, sometimes decades.

Undertaking a home renovation. Whether you’re adding a second story to your bungalow or an in-law suite to your basement to bring in some extra rental income, refinancing and borrowing by way of a second mortgage or a home equity line of credit (HELOC) can be an easy way to access the cash you need.

Buying an investment property. The down payment requirement on an investment property is often heftier than a principal residence. You need as little as 5% down to buy a principal residence (if you’re buying a property under $500,000), whereas you’re required to make a 20%+ down payment on a rental property. If you don’t have the cash on hand, you might consider refinancing the mortgage on your primary residence and pulling equity out to use as a down payment on the investment property.

How Do You Qualify for Refinancing?

To be able to refinance your mortgage, you need to qualify. That involves having enough income to do so.

If you obtained your mortgage prior to the January 1, 2018 mortgage stress test, you may be in for a rude awakening. Today, you’ll need to pass the stress test (prove you can afford payments based on rates that are 200+ basis points higher) in order to refinance your mortgage.

That becomes a problem when you don’t have enough income to prove you can afford much higher payments. If you can’t pass, you can’t refinance, plain and simple.

On that note, if your income situation has changed since you initially took out your mortgage—you went from being a full-time salaried employee to a full-time freelancer, for example—you may not be able to refinance. The reason being, lenders like to see a two-year history of self-employed income.

Qualifying requires that your “debt ratios” be under your lender’s limit. We’re talking about the gross debt service (GDS) ratio and total debt service (TDS) ratio here.

Tips for Refinancing

Here are three of my best tips for refinancing.

  1. Shop around. Although lenders don’t typically cover your mortgage penalty, some lenders or brokers may cover other costs associated with refinancing, such as appraisal and legal fees. That reduces your out of pocket expenses and lowers your break-even point. While your local bank may be a good first stop, by not shopping around you’re potentially leaving hundreds or thousands of dollars on the table. For that reason, it’s advantageous to use a mortgage rate comparison website like RATESDOTCA. At the very least, do your own due diligence to see if the rate you’re being offered by your bank is competitive. It often isn’t.
  2. Know what to expect with a refinance. Refinancing your mortgage is like applying for a new mortgage. The lender will fully underwrite your application. As such, you’ll need to provide letters of employment, pay stubs, tax documents, your most recent mortgage statement, property tax bills and other relevant documents. It helps to have these items handy to make the refinancing process faster.
  3. Try to reduce your penalty. If you’re going to break your existing closed mortgage, try to reduce your mortgage penalty if possible. For example, if you stay with your existing lender, they may be willing to reduce the penalty.

If staying with your current lender isn’t an option, you may still be able to reduce your mortgage penalty by making lump sum payments on your mortgage before you break and refinance it. That way, your penalty will be calculated on a lower balance.

Tip: Check if your lender has a policy against prepayments within 30-90 days of you discharging the mortgage. Some do.

Sean Cooper

Sean Cooper is the author of the new book, Burn Your Mortgage. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Financial Journalist, Speaker and Money Coach, his articles and blogs have been featured in publications such as The Toronto Star, Globe and Mail, Financial Post, Tangerine: Forward Thinking blog and TheDot. You can follow him on Twitter @SeanCooperWrite.

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