Mortgage refinancing is a type of mortgage product offered to homeowners who have significant equity in their homes. Home equity can be calculated by subtracting your current mortgage balance from the current value of your home. However, a general rule in refinancing is that you can only take out a maximum amount of 80% of the value of your current home provided that your income services the new debt you will be taking on. This gives you a buffer of 20% if in case the market value drops.
There is no limit to the number of times you can refinance your current home. In most cases, Homeowners break their existing mortgage to get a lower interest rate. Normally, a dip in the mortgage rate by 2% is considered ideal to refinance, but many decide to break their existing mortgage even for a 1% reduction in interest rate. Another major reason for refinancing is to take out or liquidate some of the home equity accumulated in the home for debt consolidation, for home improvements or for investments (stocks, RRSP’s RESP’s or down payment for another property).
Based on the analysis of your current personal and general financial market situation, refinancing must be a well-thought-out decision. Refinancing brings you new opportunities. Some of these include either staying with your existing lender or choosing a new lender, deciding whether to go for a fixed or variable interest rate, going for a shorter or longer mortgage term, and increasing or decreasing your monthly payment via shortening or lengthening your existing mortgage amortization.
Before you decide, you must look at the pros and cons of refinancing.
- Since it was the lower interest rate that interested you to refinance, you get to save money, which can now be used in managing other projects of interest.
- You can access equity cash in your home and assess what your home is worth now. You can easily calculate your home equity by subtracting your home value from the outstanding debt. This way, you will also have an idea of how much the total worth of your home you have already paid.
- Refinancing gives you the option to consolidate or combine several debts instead of paying them individually. This consolidation of debts may cover your car loan, credit card outstanding bills, lines of credit, private loans and mortgage in one payment. Since these unsecured debts are often at a higher rate of interest; pooling them together into your new mortgage will help you pay more towards the outstanding principal debt rather than just the interest.
- When you decide to refinance, you have the chance to again choose between a fixed or variable rate mortgage before the new mortgage is approved.
- It is understood that no matter what benefits will follow in the long run, the initial consequence will always be incurring penalties, lawyer fees and sometimes appraisal fees on refinancing. Fixed mortgage rate users pay a penalty of three months interest or the interest rate differential payment (IRD), whichever is greater, whereas for variable mortgage rates it is only three months of interest. It may be possible that the penalties are higher than the savings at any given time near the maturity of the mortgage. Check your prepayment penalties/privileges before initiating the process.
- Consolidated debt payment can slow down or prolong the process of payment.
- Refinancing to access the existing equity may lead to more debt in addition to extra costs in the name of penalties.
- When you switch your mortgage interest type from fixed to variable or vice versa, it can lead to an increased outstanding debt payment, which may not be as per your expectations.
When should you refinance?
If you must refinance, break the existing mortgage financing earlier and take a new mortgage rate with any lender of your choice.
It is important to remember that there is still a legal penalty from the bank, which is usually equivalent to three months interest payments or more. However, refinancing early puts you in a lot better situation than when you break it in the middle of the term, where it can be a very costly decision.
- When you are near your mortgage renewal:
If you have missed the opportunity to refinance early, you can still do so towards the end of your term. Instead of renewing with your existing lender, you can shop around and see what is out there. Often, there will be better deals offered by other financial institutions that may fit your current need than what your existing lender is offering you.
- When you need a home equity line of credit:
This is a more flexible access to the equity in your home. It works the same as a line of credit but with a lower interest rate because it is secured against your home. If you take out money from it, you will still have to pay monthly interest-only payments on the outstanding balance.
Speak with us to know whether it is a good idea to refinance and what solutions and options you can avail before you take this decision.