People refinance their home for two main reasons: to access the equity in their home and turn it into cash, or to obtain a lower mortgage rate. According to the Canadian Association of Accredited Mortgage Professionals (CAAMP), more and more Canadians are turning to refinancing – in fact, 15 per cent of Canadians refinanced their mortgage in 2011, up from just 8 per cent in 2010.
In this article, we’re going to focus on refinancing for equity, which you may be considering if you’re planning on renovating your home, purchasing an investment property or consolidating your debt. In order to access this equity, you have three options. You could break your existing mortgage and begin a new one, take out a Home Equity Line of Credit (HELOC), or blend-and-extend your current mortgage.
When breaking your existing mortgage, you’re paying off your current mortgage and setting up a new mortgage. This gives you complete access to 80 per cent of the equity in your home, but also requires you pay interest on the total amount loaned from the get go. In addition, there are other fees and costs to consider, such as a penalty for breaking your mortgage.
A HELOC is different than a conventional mortgage refinance, in that it allows you to access your equity on an “as-needed” basis, instead of accessing the equity all at once. You’re able to withdraw as much or as little as you want, when you want, similar to a line of credit (LOC). You’ll only be paying interest on the amount you owe, and, as you pay off more of your principal balance, you’ll have access to more equity through your HELOC. It’s important to note that a HELOC is only available with a variable mortgage rate, and typically this rate is higher than a conventional 5-year variable rate mortgage. As of August 22, 2012, the lowest HELOC rate is 3.50 per cent, compared to a 5-year variable rate of 2.65 per cent and 5-year fixed rate of 2.99 per cent.
With a blend-and-extend, you can increase the amount of your mortgage while renewing it early at the same time, effectively avoiding penalties for breaking your mortgage agreement. However, this means you’ll be locking into another term with your lender. When blending-and-extending, your lender will calculate a “blend” of your existing mortgage rate and the current interest rate for the term you’re agreeing to in order to establish your new rate for the duration of your new mortgage term.
Comparing Your Options
|Credit Limit||80% of assessed value, minus your unpaid mortgage balance||80% of assessed value, minus your unpaid mortgage balance||80% of assessed value, minus your unpaid mortgage balance|
|Mortgage rate available||Variable/Fixed||Variable||Variable/Fixed|
|Access to equity||Lump sum||As needed||Lump sum|
|Payment type||Traditional (Interest & Principal)||Interest only||Traditional (Interest & Principal)|
The Cost of Refinancing
There are costs associated with a mortgage refinance. For instance, you’ll typically need a real estate lawyer to help you along the way since you’ll be entering a new mortgage contract, and you’ll once again need to get title insurance. If you are breaking your current mortgage, you will also have to pay a penalty fee, which can end up being a hefty cost.
“There’s no penalty for refinancing unless you’re breaking your underlying mortgage,” said Toronto mortgage broker James Laird of True North Mortgage . “If you currently have a $200,000 mortgage and want an extra $100,000 through a HELOC or blend-and-extend, then you wouldn’t be breaking your mortgage. However, if you wanted a $300,000 mortgage than you would be breaking and might face penalties.”
If you have a fixed rate mortgage, this penalty is the greater of the interest rate differential payment (IRD) or three months’ interest costs. With a variable rate, the penalty cost is three months’ interest.
If you have a collateral mortgage, then you already have additional funds built into the terms and conditions of your mortgage, since at the time of lending, the bank registers your mortgage at a higher amount than the value of your property. For instance, TD’s well-known collateral mortgages are registered at 125 per cent of the value of your home at closing. Much like a revolving line of credit, you can withdraw up to a certain percentage (typically 80 per cent) of your home’s value, repay it, and then withdraw it again. As the value of your home increases, so does the amount of money you can access through your collateral mortgage. However, the banks can not only offer your more advances on the principal, but can also increase the interest rate on your collateral loan when doing so.
According to Laird, while accessing this equity under a collateral mortgage is still technically a refinance, it’s not considered a full refinance since you won’t need a lawyer in order to access the money. Even better, you won’t be breaking your mortgage contract and therefore won’t have to pay a penalty, which will save you quite a bit of cash. Where the collateral mortgage can have a downside is at renewal time – most lenders don’t accept a collateral mortgage transfer, meaning you’ll have to break your mortgage (and pay penalties) if you’re looking to make a switch.
Many banks—including TD (as of Oct. 18, 2010) and ING direct (as of Dec. 10, 2011)—offer only collateral mortgages, so before looking into a refinance check with your lender to see whether or not your mortgage is collateral.
Calculating Your Accessible Equity
To figure out how much equity you would have available with a refinance, you’ll need to do a simple calculation using the following formula:
Accessible Equity = ([Property Value] x 80%) – Outstanding Mortgage Amount
So, for example: if your home was worth $300,000, and you had a balance of $200,000 outstanding on your mortgage, your calculation would look something like this:
Accessible Value = $300,000 x 80%
= $300,000 x 0.8
Accessible Equity = $240,000 – $200,000
This means you’d be able to access up to $40,000 of your home’s value in cash through a mortgage refinance.
Deciding which is right for you
While a HELOC is more flexible than a conventional refinance, allowing you the ability to easily take out as much or as little money as you need, when you need it, and without penalty, it could end up costing you more long-term since a HELOC rate is typically higher than a conventional variable rate, and currently is also more expensive than a conventional fixed rate (as of August 22, 2012).
“A HELOC is good for short term financing, but if you’re planning on owing for a while you’ll want a mortgage,” said Laird.
Breaking your mortgage is a less flexible way of refinancing, but could work out to be cheaper long-term (depending on your penalty). The downside is that if you are paying a penalty, that sum (which could be a few thousand dollars or more) needs to be paid upfront and all at once.
With a blend-and-extend, you’re able to access your equity without paying penalty fees for breaking your mortgage, but you’re also locking into another term with your current lender.
“If you require that flexibility of money moving in and out, than get a HELOC,” said Laird, “However, if you don’t require that flexibility, than a [more conventional] mortgage refinance makes more sense financially.”
Additionally, if the penalty to break your mortgage and refinance is extremely high, you can avoid that penalty by considering a HELOC or a blend-and-extend.
In the end, the differences between a conventional mortgage refinance, blend-and-extend, and home equity line of credit really comes down to two things: the flexibility of the loan when weighed against your needs, and the amount it will cost you to access that equity.