Should you refinance your mortgage?

This article has been updated from a previous version.

The decision to refinance your mortgage offers both opportunities and challenges. Despite its relative complexity, it’s drawing more interest from Canadian homeowners. RATESDOTCA data collected from May 2022 to 2023 showed that the number of people quoting for mortgage refinances rose by 17%.

Before taking the leap and breaking your mortgage, here’s what to consider when making this decision about your mortgage strategy.

What is mortgage refinancing?

Refinancing is a process whereby a homeowner replaces their current mortgage with a new one to pay off the remaining balance in full. It involves breaking their existing mortgage agreement and taking out another with new loan terms and conditions.

How much can I borrow through a refinance?

Typically, you can borrow up to 80% of the appraised value of your home, subtracting the remaining balance of your home. The amount you borrow through a refinance can also be influenced by your creditworthiness and the lender’s policies.

For example, if your current mortgage is 40% of your home’s value, then you can borrow the remaining 40%, bringing the total amount of your mortgage loan to 80% of your home’s value.

How often can I refinance?

There is no standard number for how many times you can refinance your mortgage. However, your lender will typically set a limit. The general rule is to have 20% equity or more in your home for a cash-out refinance.

Why you may choose to refinance

According to the 2023 CMHC mortgage consumer survey, 19% of homeowners refinanced their mortgages, mostly to consolidate debts or to undertake renovation projects.

Financial situations can drastically change at any moment. Maintaining a mortgage can be challenging, particularly when faced with rising interest rates and disruptions or changes in income. Here are some reasons why you may consider refinancing your mortgage:

Capitalizing on low interest rates: With the recent hikes in interest rates set by the Bank of Canada (BoC), homeowners may find themselves facing higher borrowing costs. Those who recently entered the housing market or are approaching mortgage renewals may consider refinancing to potentially capitalize on future rate drops.

Accessing home equity: Refinancing can help homeowners access any accrued home equity. Refinancing allows you to leverage increased property value, freeing up more money for things like home improvements.

Adjusting mortgage type: You can refinance to extend your mortgage amortization to lower your monthly mortgage payments, or switch from variable-rate to fixed-rate or vice versa.

Consolidate debt. If you have debts with high interest rates, think about merging them with your mortgage. Mortgages usually (aside from recent rate hikes) have low interest rates (much lower than the average 20% rates on credit cards), so you could potentially save on interest payments.

Buying an investment property. The down payment requirement on an investment property is often heftier than a principal residence. You only need 5% upfront to buy a home (if you’re buying a property under $500,000) compared to a 20%+ down payment on a non-owner-occupied rental property.

So, if you don’t have the cash on hand, consider refinancing the mortgage on your primary residence and pulling equity out to use as a down payment on the investment property.

Related: Should I refinance my mortgage?

How to qualify for a mortgage refinance

Here are the key requirements to consider when refinancing your mortgage:

Home ownership duration: The type of mortgage you have and the amount of equity you have in your home will determine your pre-payment penalty. If you have a closed mortgage, the fees you’ll incur will depend on how much time is left in your mortgage.

Credit score: You’ll typically need a credit score of at least 640-680.

Home equity: The minimum requirement is 20% equity.

Debt-to-income ratio: This is calculated by combining all your recurring monthly debt and dividing it by your gross monthly income. You’ll usually need a number that’s 50% or lower.

Mortgage stress test: You have to pass the stress test to determine your ability to repay your refinanced mortgage – if interest rates increase.

When do I need to pay a pre-payment penalty, and how much is it?

Your mortgage lender may charge you a pre-payment or breakage fee if you do any of the following:

• Pay more than the allowed amount toward your mortgage
• Break your mortgage contract
• Transfer your mortgage to another lender before finishing your term
• Pay back your entire mortgage before the end of your term, including when you sell your home

Penalties differ across lenders and depend on the mortgage type and terms– whether it’s fixed or variable, five- or ten-year, your existing rate, and rate type, among other things.

Variable-rate holders pay the first three months of interest as the pre-payment penalty. With fixed-rate mortgages, the pre-payment fee is either three months of interest on the amount prepaid or the interest rate differential (IRD). The latter will typically be opted for if the interest rate on your mortgage is higher than the current interest rate and if you signed your current mortgage contract less than five years ago.

IRD is the difference between the remaining interest left on your original fixed rate loan and the amount of interest you will be charged on the new variable rate loan.

Pre-payment penalty example

• Outstanding mortgage amount: $500,000
• Current interest rate: 6%
• Number of months left in term: 36 months left in a five-year term
• Current posted interest rate for a mortgage with a 36-month term offered by lender: 4%

Your proposed pre-payment penalty fee comes to either $22,500, which is three months’ worth of interest on what you still owe, or an IRD of $30,000, which is the higher of the two amounts.

Keep in mind, you may also have to pay other additional fees such as, any legal and appraisal fees, mortgage application fees, and broker fees.

Skip the penalties with pre-payment privileges

Pre-payment privileges allow you to pay off your home loan faster, as long as it's explicitly outlined in your mortgage agreement with your lender. Without this inclusion, opting for accelerated payments can result in penalties.

The exact terms of your pre-payment privileges vary depending on your lender but can take the form of lump sum payments, regular installments, or both for up to 10 to 20 per cent. The pre-payment amount would be subtracted from the remaining principal balance on the loan.

Tips for refinancing

Here are three tips for refinancing:

Know what to expect with a refinance. Refinancing your mortgage is like applying for a new mortgage. The lender will fully underwrite your application. This means you’ll need to provide letters of employment, pay stubs, tax documents, your most recent mortgage statement, property tax bills and other relevant documents.

Apply for pre-approval once you’ve selected a lender. This lets you know how much you can borrow and streamlines the borrowing process.

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. This reduces your out of pocket expenses and lowers your break-even point.

While your local bank may be a good first stop, you may potentially leave hundreds or thousands of dollars on the table if you don’t shop around. Do your own due diligence to compare rates online and make sure that the rate you’re being offered by your bank is competitive.

Read more: Mortgage renewals and the stress test: How it works