Refinancing a mortgage involves replacing your current mortgage with a new one, typically to obtain better loan terms, interest rates, or payment options.
Refinancing can be a valuable tool for homeowners to reduce their monthly payments, shorten their loan term, or tap into the equity in their property.
However, the process can be complex, and many factors must be considered when deciding whether to refinance.
This article will explore what it means to refinance a mortgage in Canada.
We’ll discuss the benefits and potential drawbacks of the process and what you should know before deciding whether it’s the right choice for you.
What is Mortgage Refinancing
Mortgage refinancing is when a borrower replaces their existing mortgage loan with a new one, typically to obtain better loan terms, interest rates, or payment options.
A refinance allows borrowers to pay off their current mortgage and take out a new one with more favourable terms.
There are several reasons why for refinancing your mortgage.
For example, reduce your monthly payments, shorten the loan term, or switch from an adjustable to a fixed-rate mortgage to secure a more stable interest rate.
Refinancing can also provide a means to tap into the equity in your property, providing you with the cash for home improvements or other expenses.
The new mortgage obtained through a refinance pays off the old one, and you start making payments on the new loan according to the new terms.
The process typically involves:
- Applying for a new loan.
- Providing documentation.
- A credit check and appraisal are like obtaining an original mortgage.
Learn More: Complete Guide on Refinance a Mortgage in Canada
Four Reasons to Refinance Your Mortgage
Take Advantage of Lower Interest Rates:
Refinancing to a lower rate could greatly decrease your monthly payments if interest rates have dropped since you took out your original mortgage.
Housing is often the most significant expense, so lowering your housing costs can give you more financial flexibility to spend on other things or put more money towards savings and investments for the future.
Modify the Length of Your Mortgage:
You may extend or shorten your mortgage term based on your circumstances and objectives.
Extending the term will lower monthly payments but increase the interest paid throughout the mortgage.
Conversely, shortening the term will lead to higher monthly payments, but you’ll own your home sooner and pay less interest overall.
Alter Your Loan Type:
Depending on the interest rate outlook and your plans for the property, you may opt to switch your loan type.
For instance, if you have a variable-rate mortgage, consider switching to a fixed-rate mortgage to protect yourself against fluctuations in interest rates.
Switching to a fixed mortgage rate ensures a stable monthly payment throughout the mortgage and allows you to make more informed financial plans.
Conversely, you may switch from a fixed to a variable mortgage rate if you anticipate future declines in the prime mortgage rate.
Access Home Equity:
If the value of your home has increased, you may have a large amount of money tied up in it. Refinancing allows you to cash out some of that equity.
Liquid cash can provide you with the needed money to carry out significant expenses such as home improvements or college tuition for your children.
You can also use the mortgage refinance to pay off other high-interest consumer debts (debt consolidation).
Learn More: Cash-Out Refinance In Canada, Best Explained
Four Drawbacks of Refinancing Your Mortgage
While mortgage refinancing can provide many benefits, such as lower interest rates, improved loan terms, and access to home equity, there are also potential drawbacks to consider.
Here are four disadvantages of mortgage refinance:
Higher Long-Term Costs:
Refinancing your mortgage may require an extension of its amortized period for you to qualify.
The extended amortized schedule will result in higher total costs over the life of the loan.
For example, if you have a remaining mortgage balance of $300,000 with a 20-year term and 3% interest rate and refinance it to a 30-year at 2.5% interest, you may have lower monthly payments, but you will end up paying more interest over time.
Closing Costs and Fees:
Refinancing involves closing costs and fees, such as appraisal, application, legal, and loan origination fees.
These fees can add up and impact the overall financial benefit of refinancing.
For instance, you can pay around 1-2% of your mortgage balance in closing costs and fees.
Risk of Default:
Refinancing can provide access to the equity in your home, but it also increases the risk of default if you’re unable to make the new mortgage payments.
The risk of default is high if you opt for a home equity line of credit (HELOC) when refinancing.
This is because a HELOC comes with variable interest rates, which means your monthly payments can increase if interest rates go up.
Credit score impact:
Refinancing your mortgage can temporarily lower your credit score, as lenders will perform a credit check and assess your financial situation.
If you have recently taken on new debt or missed payments, this could negatively impact your credit score and make it harder to obtain favourable loan terms.
However, your credit score will recover if you make your timely payments.
When is the Right Time to Refinance Your Mortgage?
If there has been a change in interest rates since you obtained your mortgage, now could be a great time to refinance.
Refinancing is also viable if your financial situation or goals have changed.
For example, if you have received a substantial income raise at work, have additional income sources.
You may also want to pay off your home faster or reduce your monthly expenses to improve your work-life balance.
There are numerous factors to consider when making this decision, and with great advice from a mortgage professional, you can ultimately determine the right time to refinance your mortgage.
How Does Mortgage Refinance Work in Canada?
We have discussed what mortgage refinancing is, why it might be beneficial, and when it may be the right time to consider it.
So, what are the steps involved in refinancing your mortgage?
Calculate the Costs:
Before making any decisions, it’s essential to evaluate the financial impact of refinancing.
When you see banks offering lower interest rates than your current mortgage, it can be tempting to proceed with refinancing quickly.
However, hold on and consider all the expenses involved. Terminating your current mortgage may result in fees charged by your existing mortgage lender.
There may be additional costs, such as home appraisals and legal fees.
Consider the length of time you plan to stay in your home and whether the savings from the reduced interest rate outweigh the cost of refinancing.
Select the Right Refinance Methods for Your Goals:
Before embarking on the mortgage refinancing process, it’s also essential to clearly understand what you want to achieve.
Several refinancing options are available, so take the time to assess your financial goals to determine how refinancing your mortgage can help you achieve them.
Let’s look at how you can use the four types of mortgage refinance to achieve your financial and lifestyle goals.
Refinance Method I: Changing Your Mortgage Terms
To modify the terms of your mortgage, you’ll need to end your current mortgage agreement and obtain a new one.
This can be done with either your current mortgage lender or a new lender.
This option is ideal if your goal is to lower your interest rate, switch from a fixed to a variable rate, or alter the length of your mortgage term.
Refinance Method II: Accessing Home Equity through a HELOC
If you need to tap into the equity in your home, a Home Equity Line of Credit (HELOC) may be an option for you.
This loan is backed by your home and operates like a standard Line of Credit account but is secured against your house and often offered at lower interest rates.
You can likely get a HELOC from your current mortgage lender, but it may be worth exploring other lenders for better terms.
Before deciding, it’s crucial to consider the interest payments and added risk of taking on a HELOC compared to the benefits of accessing the equity in your home.
Refinance Method III: Blending and Extending the Mortgage
Another option is blending and extending your mortgage to avoid mortgage prepayment charges.
If your home has enough equity, you can borrow more from your current lender at market interest rates.
This will result in a blended interest rate that combines your current rate with the current market rate.
Although this approach is usually cheaper than breaking your mortgage and switching to a new lender, the interest rates may be higher.
Carefully evaluate which option will work best for you.
Learn More: Blended Mortgage In Canada; Plain And Simple
Choosing a Suitable Mortgage Lender:
Once you have decided which refinancing option fits your financial goals best, it’s time to select a mortgage lender.
If you opt for a blend and extend, your current lender will be the right choice.
You can compare your current and potential new lenders for a Home Equity Line Of Credit (HELOC).
If you want to change the terms of your mortgage, it’s best to compare different lenders to find the one that suits your needs.
The following steps in the process will be similar to obtaining your first mortgage.
Compare interest rates and other fees, terms, and conditions each lender offers.
For instance, if you may rent out your property in the future, verify which lenders allow it. If you plan on making overpayments, check for any penalties.
Also, ensure you meet the eligibility criteria, such as having sufficient equity in your home (typically 20%) and a credit score that meets the lender’s approval guidelines.
Learn More: View The Best Mortgage Lenders in Canada
Your Credit Score and Mortgage Refinancing
Applying for mortgage refinancing could impact your credit score if not done right.
Just like applying for any credit product, having your credit record hard hit by different providers will lower your credit score by a few points.
It is recommended to avoid applying for multiple loans or conducting credit checks with multiple lenders simultaneously.
It’s also a good idea to check your credit score ahead of time and make any necessary improvements to increase your chances of passing the lender’s credit check.
You can use approvU to shop over 25 mortgage lenders and check your credit score only when you are ready to proceed with your application—no multiple hits on your credit record.
Also, refinancing to release equity increases your debt, which could hurt your credit score, but paying off higher-interest debts like credit cards with equity can improve your score in the long run.
While refinancing may temporarily impact your credit score, keeping up with your mortgage payments will increase your credit score over the long run.
Refinancing Your Mortgage: Can It Make Your Home Work For You?
Refinancing can provide several advantages to help you reach your financial goals.
Refinancing can offer solutions if you lower your monthly payments, pay off your mortgage earlier, access the equity in your home, or consolidate your high-interest debt.
However, it is essential to thoroughly evaluate all the costs, terms, and conditions before making final decisions, as refinancing can also have implications.
By carefully considering all the factors, you can ensure that refinancing your mortgage works for you and helps you achieve your financial objectives.