It’s no secret that many Canadians have been through tremendous financial, emotional, and in some cases, physical stress due to COVID-19. Many have lost their jobs, while for others working from home has become part of their new normal.
While many Canadians are grappling with reduced incomes and relying on the plethora of government support programs to make ends meet, others have been lucky enough to maintain their incomes. For those lucky earners who are homeowners, the low interest rate environment created by COVID-19 offers a unique opportunity to reduce monthly housing costs through mortgage refinancing.
But is refinancing the right choice for you? I was in this same position just a month ago and faced the decision to refinance my mortgage to take advantage of lower interest rates caused by COVID-19. Here’s how I determined if I should refinance my mortgage in 2021.
What is mortgage refinancing?
Refinancing your mortgage is the process of breaking your current mortgage and starting a new one with a new lender. Your new mortgage pays off your old mortgage, and you can borrow additional money or choose different conditions from your original contract.
Benefits of refinancing your mortgage
My mortgage broker was the one who brought me the idea to refinance my mortgage. She got in touch with me and highlighted the benefits of refinancing, including:
1. Lower monthly payment and less interest paid
Mortgage interest rates in Canada have dropped to historically low levels since the global pandemic began, which means if you refinance your mortgage now, you’ll likely lower the interest rate on your mortgage. A lower interest rate means you’ll pay less interest over the life of your mortgage, and you’ll lower your monthly payment. But just how much lower? The table below shows the impact of three different interest rates for a home with a remaining mortgage of $400,000 and 20 years left on the mortgage amortization period.
|Total interest paid||$141,590.76||$98,942.76||$58,402.96|
*Rates are based on historical discounted 5-year mortgage rates.
When I explored refinancing my mortgage, I found that I could lower my interest rate from 2.29% to 1.84%. This drop would lower my monthly payment by $174 per month – that number got my attention!
2. Accessing equity
One of the most significant benefits of refinancing your mortgage is to access the equity in your home. Your home equity is your home’s value minus your mortgage’s balance. This equity is available for you to withdraw and use in many different ways, including:
- Pay off high-interest debt
- Home renovations
- Post-secondary education
- Purchasing an investment property
You can access up to 80% of your home equity by increasing your mortgage value when you refinance. To determine how much equity you can access, you can use Ratehub.ca’s refinance calculator, or we’ve broken down the formula below.
The accessible equity in your home is 80% of the home’s value, less the current mortgage amount. So if your home is worth $500,000, and your current mortgage amount is $250,000, the calculation is:
(Home value x 80%) – Mortgage Amount
|$500,00 x 80% = $400,000 – $250,000 = $150,000|
In my case, I added $5,000 to my mortgage amount to cover the fees associated with refinancing (more on that below).
Finally, let’s not forget the fact that we’re in a global pandemic, and refinancing your mortgage means you have the chance to lock in your mortgage interest rate for up to five years. That guarantee of a lower interest rate for such a long period can take some pressure off your finances, help you put away extra cash for emergencies, and provide stability in a world where even basic securities can seem unreliable.
Downsides of refinancing your mortgage
Of course, refinancing your mortgage isn’t all upside. There are fees and penalties to consider before taking the plunge with refinancing.
1. Prepayment penalties
When you refinance your mortgage, you break your existing mortgage agreement and apply for a new one. Breaking your mortgage results in a prepayment penalty charged by your bank. The prepayment penalty is calculated as either the three months’ interest or the interest rate differential (IRD), whichever is greater. To find out your prepayment penalty, use the Ratehub.ca Penalty Calculator, or call your lender and ask. Prepayment penalties can be quite significant, ranging from several thousand to tens of thousands of dollars, so it is essential to have this information to decide whether refinancing is worthwhile.
In my case, my mortgage was up for renewal in about eight months. My mortgage is on the smaller side (around $220,000), so the prepayment penalty was around $1,200 – a reasonable amount for this refinance.
2. Extra costs
On top of your prepayment penalty, there are other costs associated with refinancing your mortgage. Here’s a breakdown of the fees you may pay:
- Mortgage discharge fee ($200-$350)
- Mortgage registration fee ($70)
- Legal fees ($700 – $1,000)
While none of these fees are excessive, they must be paid upfront and can catch you by surprise if you aren’t prepared for them. In my case, the extra $5,000 I added to my mortgage amount more than covered the fees I incurred.
3. Qualification problems
Finally, 2020 was a turbulent year, and if you experienced financial upheaval, you aren’t alone. Refinancing your home involves applying for an entirely new mortgage, which means you’ll need to prove you can afford your monthly mortgage payments. Your lender will use your credit score, income, and debt information to determine whether you qualify for your mortgage amount. Requiring this information means that if you’ve recently become unemployed, taken on new debt, or missed payment resulting in a lowered credit score, you may not be able to qualify for a new mortgage at this time.
Pros and Cons of refinancing your mortgage
Here are a few things to consider when you’re thinking about refinancing your mortgage.
- Save money by lowering your monthly payment and reducing the total interest paid
- Ability to access up to 80% of the equity in your home for debt consolidation, renovations, and more
- Add stability to your budget by locking in an ultra-low mortgage rate
- Prepayment penalties can cost thousands of dollars
- Extra fees
- Possibly difficulties qualifying due to unemployment or debt
The bottom line
The global pandemic in 2020 led to some genuinely unique economic conditions and some of the lowest mortgage rates on record. Yes, the pandemic was extremely hard on many Canadians, but if you’ve managed to maintain your income, refinancing your mortgage offers benefits. Refinancing allows you to take advantage of low interest rates, helps you save hundreds on your monthly payment and thousands in interest over the long term. If you are considering refinancing, an excellent first step is to contact a mortgage broker, who will ask some basic questions and then shop your application around to lenders to help you secure the best mortgage rate.
As for my refinance story, I ended up refinancing my mortgage through my mortgage broker in January 2021. My mortgage was up for renewal in about eight months, so the extra fees I incurred were worthwhile for the lower interest rate and the subsequently smaller monthly mortgage payment. I plan to save the extra money and build up my emergency fund so that if I do end up losing my job due to the pandemic, I’ll have an extra cash cushion to fall back on and lower monthly costs to manage.