How Does Refinancing A Mortgage Work In Canada?

    Refinancing Your Mortgage In Canada: What You Need To Know

    Between real estate agent fees, insurance, and the down payment for the actual property, becoming a homeowner is an expensive process. On top of that, you’ll likely have to take out a mortgage and pay that off every month. The costs can really add up, especially if you got saddled with high-interest rates or unfavorable loan terms.

    The good news is that there’s a way out, and it’s a lot easier than you might think. Mortgage refinancing can help you get better rates, consolidate your debt, and save money in the long run.

    Keep reading for a full breakdown of how mortgage refinancing works in Canada.

    What Does Refinancing A Mortgage Mean?

    When you refinance your mortgage, you basically take out a second loan to completely pay off the first one. This new mortgage comes with new interest rates and loan terms, which are often more favorable than the terms of your initial mortgage. This gives you the freedom to choose what type of mortgage loan you want to have and which mortgage company you want to work with.

    Since your original loan is now paid off, you only have to think about paying off your second loan. This could effectively lower your monthly costs and save you tons of money down the line. 

    Of course, there are other costs and risks associated with refinancing, especially if you break your existing mortgage early. We’ll get into all of that in just a moment.

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    Why Would You Want To Refinance Your Mortgage?

    There are plenty of advantages to refinancing a mortgage loan. Below are just some of the most common reasons that homeowners refinance.

    Lower Interest Rate

    The biggest benefit of refinancing is that you can lessen the interest rate on your new mortgage. Even a small 1-2% decrease in interest can save you hundreds, if not thousands, of dollars a year. And if market interest rates are particularly low at the time you refinance, you can lock them in before they increase.

    Plus, lower interest means that more of your money goes toward your home equity, so you’ll own your property much sooner than if you didn’t refinance.

    Change Loan Terms

    If you decide that you want to pay your mortgage loan faster than the term you agreed on, it’s not as easy as paying the whole amount. Refinancing the mortgage lets you switch mortgage types (e.g. variable or fixed-rate) and terms (e.g. 15 years, 30 years) so that it aligns more with your current financial situation.

    Access Equity In Your Home

    Every time you make a mortgage payment, you build home equity, which is the current market value of your home minus any loans or liens on it. You can take a loan against your equity to finance a renovation, upgrade, investment, or even education. You’ll have to pay it back to regain equity, of course, but it’s a good way to get money on-hand in the meantime.

    Consolidate Debt

    Having multiple loans with different lenders can make it very difficult to pay off all of your debt. Instead of juggling varying interest rates and due dates, refinancing can consolidate all of that into a single loan. It’s much easier to manage one interest rate and monthly payment versus several.

    It’s not just home loans that you can combine, either – you can lump credit card debt, auto loans, and other lines of credit together.

    When Should You Consider Refinancing Your Mortgage?

    Although refinancing a mortgage comes with many potential benefits, it’s not the right choice for everyone. There are risks to refinancing, as with any kind of debt. 

    If you want to break your current mortgage, you’ll likely have to pay a prepayment penalty fee. You’ll also have to shoulder the cost of reappraising your home. There are many other expenses as well, including legal fees. In some cases, the interest rate savings aren’t enough to make the process worthwhile.

    Here are some scenarios in which you may want to consider refinancing:

    • You plan on staying in your home for more than a few years, which allows you to recoup the losses from refinancing fees.
    • Whatever penalties or fees you might incur are less than the savings you’ll have from the lower interest rates in the long run.
    • You’ve done your research and know for sure that switching loan types is the right call.
    • You want to switch from a fixed-rate home loan to a variable interest one or vice versa.
    • You want to take advantage of significantly lower market interest rates. 
    • You want to shorten your loan terms so that you can build home equity faster.
    • You need to cover a major expense like home renovation or education. 
    • You can commit to paying off your debt even without the “incentive” of high-interest loans.
    • You can avoid the temptation of taking on more debt with the savings you get from refinancing.
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    How Does Refinancing A Mortgage Work In Canada?

    When we talk about refinancing a mortgage, there are actually several ways to go about it. We’ll discuss three of the most common: breaking a mortgage, taking out a home equity line of credit, and blending or extending the mortgage you already have.

    1. Breaking Your Existing Mortgage

    Mortgages are set on a fixed term, usually 10, 15, or 30 years. You can’t change your interest rate, loan type, or even payment period for the duration of your mortgage. So if you want to negotiate for better terms or rates, you might have to break your mortgage early by taking out a new home loan to pay for it in full.

    The biggest problem with breaking a mortgage is that there’s a penalty. Prepayment charges are usually equal to three months of interest. If that plus the other fees are more than what you would save, then breaking your mortgage might not be the right financial decision.

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    2. Adding HELOC (Home Equity Line Of Credit)

    A home equity line of credit allows you to borrow a percentage of your home’s market value. The maximum for most lenders is at 65% of the purchase price. As your equity in your home increases, your credit limit does as well. Most lenders won’t impose a fixed repayment amount, but you are on the hook for any interest that you accrue.

    Generally, you can borrow as much as you need as many times as you need to, as long as you’re within the limit. This is different from an equity loan, where you get a lump sum at the start and pay it out in installments.

    Since the loan is secured, you’ll get much lower interest rates compared to other refinancing options. However, your options are limited – in many cases, you can only take out a HELOC with your current lender.

    3. Blending & Extending Current Mortgage

    If consolidating your debt or accessing the equity in your home is the top reason that you want to refinance your mortgage, then this option is worth looking at. 

    Blending a mortgage refers to combining two or more existing loans into one. The higher interest rate from the first loan will be blended into the lower interest rate of the second loan to give a new rate that’s somewhere in the middle.

    This can be done in two ways: blend and extend, where you get a new interest rate and extend the payable term for your loan; and blend to term, where you keep the term on your original term and change only the interest rate.

    How Much Does It Cost To Refinance A Mortgage?

    When you’re considering refinancing your mortgage, make sure that you take into account all of the costs – not just the new rate or term. In some cases, the lower interest rate isn’t enough to make up for the total cost of prepayment charges, legal fees, reappraisal, and other expenses.

    The prepayment penalty for fixed-rate mortgages is either three months’ worth of interest or the interest rate differential (IRD), whichever is higher. For variable mortgages, it’s the equivalent of three months’ interest. 

    Generally, it’s a good idea to refinance your mortgage if the interest rate falls 2%, although some experts believe that even a 1% dip is enough to recoup your losses. Refinancing typically costs 3-6% of your remaining loan balance.

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    Tips For Refinancing A Mortgage

    Are you interested in refinancing your mortgage? Make sure to keep these tips in mind:

    • Evaluate current market conditions: The current state of the housing market is a huge factor in determining whether or not refinancing is worth it. As market values drop, the cost to refinance a mortgage will likely go up. Timing is everything in real estate.
    • Refinance annually: The best way to stay on top of your mortgage options is by reassessing it every year. Even if circumstances weren’t right in one year, things might fall into place in the next. Home equity and market shifts are two things that influence your refinancing rates that may change with time.
    • Do your research: Understanding the different loan types is the key to choosing the right one for your current financial situation. Each has its own advantages – fixed-rate mortgages are predictable, variable-rate mortgages fluctuate with the market (potentially resulting in lower rates for certain months), and combination rate mortgages are the best of both worlds.
    • Get all of your documents together: It’s important to have your documentation in order before you begin your application. After all, you don’t want to go through the entire process only to be blocked by a missing requirement. Ask potential lenders and mortgage companies for a list of documents during your initial probe.
    • Work with a mortgage professional: Mortgage brokers can help you compile your documents, fluff up your loan application, and advise you on the current market situation. Of course, their services don’t come for free, so factor that into your costs if you go this route.
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    • Know your break-even figure: A lower interest rate isn’t always better. Do the math to make sure that you’re actually saving money in the long run.
    • Consider a government-insured loan: The Canadian government offers many government-backed mortgages that can be used to refinance your existing one. It’s an especially attractive option for people with poor credit since they often have looser requirements.
    • Plan for the future: The biggest mistake you can make is to not plan for the future. While refinancing might be the right option for you now, your financial situation could change. Plus, market rates are constantly changing – acting now (without any in-depth research or an expert eye guiding you) could lock you out of better rates down the line.

    Conclusion

    Refinancing a mortgage can be the smartest financial decision you can make as a homeowner – if you do your research, that is. You can lower your rates, build equity much faster, manage your debt better, and finance major expenses that you otherwise would not have been able to.

    Wesley Mortgage, LLC can help you save money on your mortgage. Contact us, and we’ll help you figure out if refinancing is the right choice for you.

    Written By Ed Wallace
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