Mortgage refinance

What is a mortgage refinance?

Refinancing a mortgage means paying off your existing mortgage and replacing it with a new one, typically to access your home's equity, secure a lower interest rate, consolidate debt, or change your mortgage terms. In effect, you're renegotiating your original mortgage agreement based on your current financial needs and circumstances.

In Canada, homeowners can generally refinance up to 80% of their home's appraised value, less any outstanding mortgage balance. For example, if your home is worth $800,000, you may be able to refinance up to $640,000 (80% of its value). If you still owe $400,000 on your current mortgage, you could potentially access up to $240,000 in home equity ($640,000 less your remaining mortgage balance of $400,000), subject to lender approval and qualification requirements.

Reasons to refinance your mortgage

A mortgage refinance can be a useful financial tool when your needs have changed since you first took out your mortgage. Mortgage refinancing can also be used to access equity in your home and to consolidate your debts. Here are a few ways borrowers can benefit from a mortgage refinance. 

1. Getting a lower interest rate

If mortgage rates have fallen since you took out your mortgage, refinancing could help reduce your borrowing costs and potentially lower your monthly mortgage payments. Depending on your mortgage balance and the size of the rate reduction, even a modest decrease in your interest rate could result in meaningful savings over time. Refinancing at a lower rate may be particularly worthwhile if you have several years remaining on your mortgage and expect the long-term savings to outweigh the costs of refinancing. However, refinancing before the end of your term usually comes with penalties.

2. Accessing equity (cash) in your home

For many homeowners, their home is their largest asset. Refinancing can provide access to some of the equity you've built over time, allowing you to borrow against your home's value without having to sell it. Homeowners commonly refinance to fund home renovations, cover education expenses, invest, help family members with major purchases, or create a financial cushion for unexpected costs. Because mortgage rates are often lower than other forms of borrowing, accessing equity through a refinance can be cost-effective to finance large expenses.

3. Consolidate debt

If you have high-interest debt, such as credit card balances, personal loans, or lines of credit, refinancing your mortgage may allow you to consolidate those debts into a single payment at a lower interest rate. By rolling higher-interest debt into your mortgage, you may be able to reduce your monthly payments and simplify your finances by managing fewer accounts. However, it's important to remember that mortgage debt is repaid over a much longer period, so consider both the short-term payment relief and the long-term cost before refinancing.

4. Change mortgage features

Refinancing gives you an opportunity to adjust your mortgage to better align with your current financial goals. For example, you may choose to switch from a variable-rate mortgage to a fixed rate if you want the certainty of predictable payments, or move from a fixed rate to a variable rate if you're comfortable with rate fluctuations and believe interest rates may decline in the future. You may also refinance to change your amortization period. Extending your amortization can lower your monthly mortgage payments and improve cash flow, while shortening it can help you pay off your mortgage faster and reduce the amount of interest paid over time.

Costs of refinancing your mortgage

Depending on your lender, mortgage type, and where you are in your term, refinancing may trigger penalties and closing costs that can add up to thousands of dollars. Before refinancing, compare these costs against the potential savings or financial benefits to determine whether the move makes sense for your situation.

• Prepayment penalties: If you refinance before the end of your mortgage term, your lender is likely to charge a prepayment penalty for breaking your mortgage early. For variable-rate mortgages, the penalty is usually three months' interest. For fixed-rate mortgages, the penalty is generally the greater of three months' interest or the interest rate differential (IRD), which can amount to several thousand dollars.
• Legal fees: Refinancing requires legal work to discharge your existing mortgage and register the new mortgage on title. Legal fees can range from several hundred to more than a thousand dollars, depending on the complexity of the transaction and your location. Some lenders may cover part or all of these costs as part of a refinance promotion.
• Home appraisal fees: Lenders require a home appraisal to confirm the current market value of your property before approving a refinance. Appraisal costs range from $300 to $500, although some lenders may absorb this expense.
• Other fees: Depending on your lender and mortgage product, additional costs may include discharge fees, registration fees, or administrative charges.

How do you qualify for a mortgage refinance?

Qualifying for a mortgage refinance is similar to qualifying for a new mortgage. Lenders generally consider the following factors:

• Home equity: Most lenders allow homeowners to refinance up to 80% of their home's appraised value. The more equity you have, the more flexibility you'll generally have when refinancing. 
• Income and employment: You'll need to demonstrate that you have sufficient income to support your mortgage payments and other financial obligations. Common documents include recent pay stubs, T4s, Notices of Assessment, or business financial statements if you're self-employed.
• Credit score: Lenders review your credit history to assess how you've managed debt in the past. A higher credit score may improve your chances of approval and help you qualify for more competitive mortgage rates.
• Debt service ratios: Lenders use debt service ratios to determine whether you can afford your mortgage payments. The gross debt service (GDS) ratio measures the percentage of your income required to cover housing costs, while the total debt service (TDS) ratio includes both housing costs and other debts, such as credit cards and car loans. Most lenders prefer a GDS ratio of 39% or less and a TDS ratio of 44% or less.
• Mortgage stress test: If you're refinancing with a federally regulated lender, you'll need to pass the mortgage stress test, which measures whether you could still afford your payments if interest rates were higher than your contract rate.
• Your home's value: Lenders also require an appraisal or valuation of your property to confirm its current market value before approving a refinance

How to refinance your mortgage

While the refinancing process is similar to applying for a new mortgage, there are additional considerations, including prepayment penalties and closing costs. Here's how the process works in Canada.

Step 1: Determine whether refinancing makes sense for your situation

Start by identifying why you want to refinance. Are you looking to access home equity for renovations or other major expenses? Consolidate higher-interest debt? Secure a lower interest rate? Or adjust your mortgage features, such as switching between a fixed and variable rate? Understanding your goal will help you determine whether refinancing is the right solution and what type of mortgage product best suits your needs.

Step 2: Review your financial position and home equity

Because refinancing requires you to requalify for a mortgage, lenders will assess your current financial situation. Before applying, review your income, employment status, credit score, and existing debt obligations. Lenders will also calculate your debt service ratios and may require you to pass the mortgage stress test. Understanding where you stand financially can help you determine whether you're likely to qualify and how much you may be able to borrow.

The amount you can borrow depends largely on the equity you've built in your home. In Canada, homeowners can generally refinance up to 80% of their home's appraised value, less any outstanding mortgage balance.

Step 3: Estimate the costs of refinancing

Before refinancing, calculate any costs associated with replacing your current mortgage. These may include prepayment penalties, legal fees, home appraisal fees, and other administrative or closing costs. Comparing these costs against the potential savings or financial benefits can help you determine whether refinancing makes sense.

Step 4: Compare mortgage refinance options

Don't limit yourself to your current lender. Compare mortgage refinance rates, terms, features, and fees from multiple lenders and mortgage brokers. While a competitive rate is important, you should also consider factors such as prepayment privileges, penalties, payment flexibility, and the lender's qualification requirements.

Step 5: Gather your documents and apply

Once you've selected a lender, you'll need to complete a mortgage application and provide supporting documentation. This would include proof of income, employment information, tax documents, mortgage statements, identification, and information about your assets and liabilities. Your lender may also order an appraisal to confirm your home's current market value.

Step 6: Complete the refinance and receive your funds

If your application is approved, your lender will issue a mortgage commitment outlining the terms of your new mortgage. A lawyer or notary will then complete the legal paperwork, discharge your existing mortgage, and register the new mortgage on title. Once the refinance closes, your previous mortgage will be paid off and any approved equity funds will be released to you. 

To truly understand if it’s a good idea to refinance your mortgage, you should speak to a licensed Canadian mortgage broker. They’ll be able to assess your personal situation at no cost to you, and help you understand what your options are. If you’re ready to refinance then they can also find you the best deals and guide you through the process.