When to Refinance Your Mortgage

Alyssa Furtado
by Alyssa Furtado February 27, 2013 / 2 Comments

Flickr: woodleywonderworks

If you’re a homeowner, you’ve probably heard of refinancing your mortgage, but do you really understand what that means? Refinancing involves getting out of your existing mortgage in order to get a new mortgage. Before you decide to refinance, it’s a good idea to calculate what it will cost, as you’ll likely incur both a mortgage penalty and legal fees.

While the upfront cost may be something you need to save and budget for, there’s a number of reasons why a homeowner would choose to refinance their mortgage. Let’s take a look at the most common reasons:

1. To take advantage of the best mortgage rates

If your original mortgage rate is much higher than today’s posted rates, it could be worth refinancing to take advantage of the better rates available. But there’s no such thing as a free lunch – it’s important to understand the penalties involved. If you have a variable rate, you’ll simply have to pay three months’ interest. If you have a fixed rate, you’ll pay the greater of three months’ interest or the interest rate differential (IRD) – both of which are explained here. So long as your penalty isn’t too high, and your new mortgage rate will give you substantial savings over the new term, it could be worth refinancing to get a better rate.

2. To take equity (cash) out of your home

Whether you want to renovate your home, purchase a second property, or you’re simply house poor and want to access some of the equity in your home, refinancing to take cash out of your home is another reason many homeowners refinance their mortgages. You can borrow up to 80 per cent of the value of your home, minus what you owe, through a refinance. For example, if your property is valued at $400,000 and you still owe $250,000, you multiply $400,000 by 0.80 and subtract $250,000 to get $70,000 – that is how much cash you can take out of your home.

Here is what it looks like when you put the numbers through our refinance calculator:

Refinance Calculation for Equity

If you want to avoid having to pay a mortgage penalty fee, you can also access 65-80% of your equity through a home equity line of credit (HELOC) instead.

3. To consolidate and pay off debt

Because mortgage rates are so low, consolidating and paying off high interest debt is another reason many homeowners will refinance their mortgages. If you’re paying off a credit card or a loan at a high interest rate, refinancing can help you consolidate all of that debt back into your home at a fraction of the interest rate. This option can help you decrease your monthly debt repayment, as well as free up your cash flow.

4. To shorten or lengthen your amortization period

If you find yourself in a financial bind, refinancing can offer you some financial flexibility. Whether you’ve lost your job or become ill, refinancing your mortgage allows you to lengthen your amortization period and decrease your mortgage payments. On the other hand, if you want to repay your mortgage sooner, you can refinance to increase your payments and shorten your amortization – although, in this case, you could also look at prepayment privileges in your mortgage agreement.

5. To lock-in your mortgage

Does the prospect of your variable rate suddenly spiking keep you up at a night? If you’re a homeowner with a variable rate and a tight budget, you might consider refinancing your mortgage to lock into a fixed rate – especially if you think interest rates will increase in the near future, and you don’t have the budget to make a larger payment than you already do.