How to Refinance Your Mortgage
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If you’re a homeowner, you may have considered refinancing your mortgage at one point. Refinancing can be beneficial in the current climate of high interest rates if your budget is stretched and you need to extend your amortization to lower your mortgage payments. It can also be beneficial if interest rates continue to fall to obtain a better interest rate before renewal.
A refinance can also be a great way for you as a homeowner with enough equity in your home to consolidate debts, fund renovations, or purchase a second property. This post will help you understand the costs involved with refinancing and help you determine if it’s a suitable strategy for you.
Key Takeaways
- Refinancing can help you benefit from lower interest rates if rates fall or lower mortgage payments by extending your amortization.
- A refinance can help you access the equity in your home to consolidate debts, fund renovations, or purchase a second property.
- Depending on your current mortgage, there may be a prepayment penalty when refinancing.
What Is a Refinance?
A mortgage refinance involves breaking your existing mortgage and obtaining a new one. You may consider refinancing for many reasons, such as utilizing the equity in your home to consolidate high-interest debts, finance renovations, or purchase a second property.
If interest rates have fallen since you obtained your mortgage, you may also consider refinancing for a better rate. You can also refinance to extend your amortization and lower mortgage payments.
Understanding Equity and Loan-to-Value (LTV) Ratio
Equity is the portion of the home that you own. Equity is based on the difference between the assessed or appraised value of the home and how much you have remaining on the mortgage.
Your borrowing limit from the lender is determined by your loan-to-value (LTV) ratio. A higher amount of equity in your home results in a lower LTV ratio. Typically, homeowners looking to refinance their mortgage do so when they have a significant amount of equity in the home.
You can access up to 80% of the home’s value through a refinance and the equity through a lump sum equity take-out (ETO) in cash. For example, if you have a home worth $600,000 with $300,000 remaining on the mortgage, you could refinance and borrow to remortgage up to a total of $480,000 (that’s $600,000 x 80%).
You could keep your $300,000 mortgage and access the additional $180,000 in cash through an equity take-out set up as a secured line of credit (HELOC) or another mortgage, or you could set up the whole amount as a $480,000 mortgage.
How to Use a Mortgage Refinance Calculator
Our mortgage refinance calculator can help you determine whether refinancing your mortgage before the term ends is financially beneficial.
To get started, input the reason for refinancing (lower my mortgage payment, access my equity, or change my amortization) and the details of your property value and mortgage balance. The calculator will help you understand the interest rates available and give you an idea of how much equity you can access.
Should I Refinance?
Conducting a cost-benefit analysis can help you determine if a refinance is worthwhile. Research the current interest rates to see if there are cost savings to refinancing that can help free up cash flow.
Additionally, weigh the pros and cons of refinancing against what you’ll pay in penalties for breaking the mortgage term early and consider the additional interest-carrying costs over the life of the mortgage if you are considering a refinance to extend the amortization.
If the penalty for breaking the mortgage is significantly high, waiting until you are closer to the end of your existing mortgage term may be beneficial before refinancing.
Costs Associated with Refinances
If refinancing before the end of your mortgage term, you will need to factor in the prepayment penalty you will incur for breaking the mortgage term early. Depending on your mortgage type, this could be either the equivalent of the interest rate differential (IRD) or 3 months’ interest, whichever is greater.
If you are refinancing at the end of your mortgage term, instead of renewing, you will still need to consider the costs of legal fees, home appraisal, and other fees you may be required to pay for refinancing.
If you are switching lenders, you will likely need to pay a mortgage discharge fee to replace the lender on your property title.
Costs of Refinancing a Mortgage
| Type of Fee | Costs |
|---|---|
| Prepayment Penalty | Depends on the lender but will typically be the higher of either the interest rate differential (IRD) or three months of interest. If refinancing at renewal, this does not apply. |
| Mortgage Discharge Fee | Depends on the lender but typically ranges from $250 to $400 |
| Mortgage Registration Fee | Depends on the province but typically ranges from $50 to $150 |
| Home Appraisal | Depends on the property location, assessors available, travelling distance to the property, type of home, and type of appraisal, but typically ranges from $300 to $500. |
| Legal Fees | This fee can range from $750 to $1,500 and higher if someone is added or removed from the title. |
Advantages of Refinancing
Obtain a lower interest rate: If interest rates are currently lower than when you first obtained your mortgage, it may be beneficial to refinance. In many cases, the lower rate could result in long-term savings even after accounting for any penalties you incur for breaking the mortgage early.
Change the amortization: In situations where you may struggle to handle your mortgage payments, increasing your amortization could help you reduce mortgage payments and improve cash flow. However, extending your amortization will result in higher interest-carrying costs over the life of the mortgage.
Access equity: Your equity continues to grow as you make mortgage payments. If you decide to use a portion of your property’s equity, a refinance can help you tap into the accumulated equity in the home. You can then use the funds for home improvements, purchasing another property, funding your children’s education, starting a business, or any other needs.
Consolidate debt: Mortgages generally have lower interest rates than other debt types, such as credit cards, unsecured loans, or second mortgages. A common reason to refinance is to consolidate and pay off these high-interest debts. You will only have a single monthly payment with a lower interest rate instead of multiple payments with varying rates, which can save you money in the long run.
Steps to Refinance Your Mortgage
Determine if refinancing is for you: Consider the expenses involved and compare them to the advantages of obtaining a lower interest rate, lowering your mortgage payments, or accessing equity.
Compare interest rates: Once you’re ready to refinance, you should compare the available rates and select the most suitable for your situation. This may involve staying with your current lender or switching to a new one. Carefully compare the rates and terms to ensure you choose the best fit.
Submit your application for a new mortgage: You must submit a new application for a refinance. This process is similar to the one you went through to fund your existing mortgage and requires the lender to assess your financial situation, arrange a home appraisal, and ensure you pass the stress test.
Stress Test & Poor Credit Score
When you apply for a new mortgage with a federally regulated lender, you must pass the stress test. This is required when switching lenders or refinancing. The stress test determines if you can still make mortgage payments if interest rates increase. The stress test rate is either your offered interest rate +2% or the benchmark stress test rate of 5.25%, whichever is higher.
Keep in mind that if you are refinancing to borrow additional funds from your home’s equity, your mortgage payments will increase. This may make it harder for you to pass the stress test. Refinancing for a lower rate or extending your amortization could help you pass the stress test more easily since both would reduce your mortgage payments.
If your credit score has taken a hit since you originally obtained your mortgage, it may be more difficult to refinance your mortgage with prime lenders. If your refinance has been denied based on poor credit, you could wait until you’ve improved your score or consider subprime or private lending, which will come with much higher rates.
Alternatives to Refinancing
If you’ve determined that refinancing isn’t for you, there are some alternatives you can explore.
Renew Your Mortgage
If you believe that the expense of breaking your mortgage term early isn’t worth the benefits, you may choose to wait until your mortgage is up for renewal. You can then revisit refinancing without a prepayment penalty if you need to make changes to your mortgage that can’t be accomplished through a renewal.
Blend and Extend
A blend and extend allows you to combine your current mortgage rate with current rates to create a weighted average and extend the mortgage term. Depending on the lender, you may have the option to revert back to your original amortization if you have a collateral charge mortgage.
Restructure
Restructuring allows you to modify your existing mortgage, changing the terms to make payments more affordable. Depending on your lender, this option may not be available. You can restructure to a lower interest rate, extend your term or amortization, or split your mortgage into 2, adding a HELOC balance to the mortgage.
Second Mortgage
You can take out a second mortgage on top of your existing one. This is typically from a different lender and will have a higher interest rate than a refinance. It is secured against the equity in your home and can be set up as a HELOC or mortgage. A second mortgage does not impact your first mortgage. However, your lender must agree to have the second mortgage behind them.
Frequently Asked Questions
Will refinancing my mortgage impact my credit score?
A hard credit check is required for the mortgage approval process. A refinance requires you to go through the approval process, which can lower your credit score in the short term.
How much does it cost to refinance?
The cost of refinancing will vary depending on your mortgage term and whether you are switching lenders. Other fees may also be required, so the total costs could quickly add up to a few hundred to thousands.
What alternatives exist if refinancing is too costly?
If the cost of refinancing outweighs the benefits, a few options are available, depending on your reason for refinancing. These options may also involve additional fees or penalties, so you must consider the total costs to see if they make sense for your situation.
If you can wait, you can avoid prepayment penalties by waiting until your mortgage is up for renewal. If you need to free up cash flow, consider restructuring or, blending and extending your mortgage. A second mortgage could be an alternative solution if you want to access equity.
Final Thoughts
When you refinance your mortgage, you are changing the terms and conditions of your current mortgage, which requires you to break your existing mortgage and obtain a new one. This can be a beneficial move to access the equity in your home, free up cash flow, or secure a lower interest rate.
It’s important to consider factors such as your lender, existing mortgage terms, and how much time is left on your current mortgage, as refinancing costs may outweigh the benefits. However, refinancing can still be worthwhile if you want to align your mortgage to better fit your needs.
Are you thinking about refinancing? Contact a mortgage professional who can help you evaluate the advantages and disadvantages of refinance and determine if it is the best option.
