Mortgage Refinance In Canada

When you refinance your mortgage, you are paying off your existing mortgage and replacing it with a new one with different terms, such as your loan amount, interest rate and amortization period. You can choose to refinance at any time during your mortgage term, or when you renew. Typically, homeowners refinance their mortgage to get better terms, such as when interest rates drop, or to access the equity in their home. You will need to requalify for your mortgage when you apply for a refinance.

How To Determine the Equity in Your Home

Your lender will use the current appraised value of your home to determine how much you’re eligible to refinance. You’re able to borrow up to 80% of the current value of your home, less the outstanding mortgage. Using a property valued at $650,000 with a $275,000 mortgage, the calculation looks like this:

If you choose not to access the equity in your home, you will keep the same mortgage amount but be able to renegotiate the terms.

However, if you choose to access the equity in your home (that is paid out in cash), your new mortgage would total $520,000 ($275,000 + $245,000). Your new mortgage would start using the current mortgage interest rate.

Keep in mind that if you took out a mortgage before the Bank of Canada (BoC) started its aggressive rate hikes, you may be renewing your mortgage at rates 2% to 3% higher.

Assuming a $275,000 mortgage at 2.25% interest with a five-year term that renews in 2024, you’d currently be paying approximately $1,200 monthly. However, that same mortgage at today’s rates of 5.59% would cost you $1,693.02 per month. And, if you increase your mortgage to $520,000 to access the equity in your home, your new monthly payment would be $3,111.

Mortgage Refinance vs Mortgage Renewal

With a mortgage refinance, you’re breaking your existing mortgage contract, paying off the balance in full and negotiating a new loan. When you renew your mortgage, you keep the existing mortgage terms, such as amortization period and loan amount, but at a new interest rate. You can refinance your mortgage at any time (including at renewal), but you renew your mortgage at the end of your mortgage term.

Here are the key differences between a mortgage refinance and mortgage renewal:

1.) You want to take advantage of lower interest rates. If interest rates have dropped since you took out your loan, refinancing your mortgage may help you save money. For example, a $275,000 mortgage with a 6% interest rate requires $1,759 a month in mortgage payments and costs $77,619 in interest over a five-year term. However, a 5% interest rate will cost you $1,599 per month in mortgage payments, but only $64,360 in interest over the five-year term, saving you $13,259. While the BoC’s overnight rate is currently at a 22-year high of 5%, most economists expect that rates have peaked and the Bank will start cutting interest rates mid-2024.

2.) You want to access the equity in your home for cash. If your home has appreciated in value, you may want to refinance to access that additional equity that would otherwise only be available when you sell. Assuming you purchased your home for $550,000 and have a $250,000 mortgage, you’d start with $300,000 in equity. Over time your home appreciates in value to $700,000; you would now have $450,000 equity in your home. With a refinance, you’re allowed to access up to 80% of that equity, less the amount owing on your mortgage. You can use this cash for anything you want, though prudent homeowners use it towards things that appreciate in value, such as a home renovation or an investment property.

3.) You want to consolidate your debt. According to a December 2023 report from Statistics Canada, household credit market debt (that includes mortgage debt, consumer credit and non-mortgage debt), measured 181.6% in the third quarter of 2023, meaning there was $1.82 in credit market debt for every dollar of household disposable income. While this level of debt isn’t at record highs, it’s among the highest levels of household debt in the G7, notes the CMHC. What’s more, servicing high debt levels can be crushing during a time of high interest rates. Credit card debt is especially punishing, with APRs around averaging 20%. Using the proceeds of a refinance to pay off high-interest debt may make sense due to the relatively lower interest rates for a mortgage.

4.) You want to change your mortgage terms, such as your amortization period or move from a variable-rate mortgage to a fixed-rate mortgage. Your amortization period is the amount of time it takes to pay off your mortgage in full. The longer your amortization period, the lower your mortgage payments; the shorter your amortization period, the higher your mortgage payments. Typical amortization periods are up to 25 years for insured mortgages, and 30 years for uninsured mortgages. If at renewal you find you’re paying a much higher interest rate, extending your amortization can make those payments more manageable. Or, if you’re currently in a variable-rate mortgage, where your mortgage payments vary in sync with the rise and fall of the BoC’s change to its key interest rate, moving to a fixed-rate mortgage can provide some stability.

5.) You’re going through a divorce. Dividing assets is a painful but necessary part of divorce proceedings. Couples with shared ownership in a home typically have three options: sell the home and split the proceeds, keep the house and one person buys out the other (which requires sufficient cash to do so) or keep the house and that person refinances and uses the equity towards buying out the other person.

Refinancing your home can give you access to cash at a cheaper interest rate than a credit card or personal loan. As noted above, even a 1% drop in interest rates can save you thousands of dollars over your mortgage term. But, it’s critical to factor in fees that accompany a refinance to ensure it still makes financial sense.

Fees for a refinance may include legal fees, appraisal costs, discharge fees (if you switch lenders) and prepayment penalties that can cost thousands of dollars.

Any time you pay off your mortgage in full before your term ends, you will likely need to pay a prepayment penalty. The terms for these charges are outlined in your mortgage agreement and can differ between lenders. In general, if you have a fixed-rate mortgage, your prepayment penalty will be three months’ interest, or the interest rate differential on the amount you prepay, whichever is greater. (A variable-rate mortgage typically only charges three months’ interest.) The interest rate differential can be complicated, but in short it’s the difference between the interest rate on your current mortgage contract when you refinance and the principal amount you would owe using the posted interest rate for a similar mortgage.

Pros

• You’re able to access equity in your house that would otherwise only be available when you sell.
• You can pay off more expensive debt with your mortgage that has a lower interest rate.
• You can lower your monthly mortgage payment to improve cash flow.

Cons

• You need to requalify for your mortgage—which means passing the mortgage stress test, potentially at a higher interest rate than when you first qualified.
• The fees to refinance can erode any potential savings.
• Extending your amortization or tapping into your equity means it’ll potentially take longer to pay off your debt.

Because you are closing your current mortgage and replacing it with a new one, the process of a refinance is very similar to securing a mortgage. While the particular steps will depend on your lender, here’s what you can expect:

• Schedule an appraisal to determine your home’s current value.
• Provide your bank with the same documentation when you first applied for your mortgage, such as proof of income, a list of your assets and debts, tax documents, etc.
• Pass the mortgage stress test, which is currently either 5.25% or your offered interest rate plus 2%, whichever is higher.
• Negotiate the terms and conditions that you want, including amortization, interest rate, mortgage term and loan amount.

If you’ve taken on significant debt since you first qualified for your mortgage or if you’ve run into problems with your credit history, it’s important to improve your credit score before you apply for a refinance to ensure you not only qualify for a refinance, but get the best terms.

Related: Best Mortgage Lenders In Canada For May 2024

A mortgage refinance can be a smart way to access the equity in your home or to improve the terms of your mortgage. However, if the costs to refinance outweigh the benefits, it may be best to wait until your mortgage term renews to access better interest rates or consider a different kind of loan, such as a home equity line of credit or personal loan.