All your friends are refinancing their mortgages. Should you?
February 1st 2021
When the Bank of Canada cut interest rates three times in one month last year, LowestRates.ca saw an unprecedented increase in the number of Canadians using our mortgage quoter to refinance their homes.
Our data revealed a 389% increase in refinancing mortgage quotes on LowestRates.ca in March 2020 compared to February 2020, and a 156% increase in March 2020 compared to March 2019.
Since then, the central bank has kept interest rates steady at 0.25% and says it will continue to do so until its inflation objective is achieved. Given that interest rates are at an all-time low, and the fact that many Canadians are taking advantage of this by refinancing their mortgages, should you do the same?
What is refinancing and how does it work?
Refinancing your mortgage allows you to pay off your old mortgage loan with a new one at a more favourable interest rate. If your lender agrees, you can borrow up to 80% of the appraised value of your home, minus what you have left to pay on your mortgage — also referred to as equity. If you have paid down part of the mortgage or you didn’t initially borrow the maximum amount, you can negotiate a new mortgage contract for a higher amount.
Generally speaking, someone will refinance their mortgage in order to take advantage of lower interest rates, switch the type of mortgage they have (fixed or variable), access the equity in their home, or consolidate their debts.
There are three ways to go about refinancing:
- Break your current mortgage and start a brand new one with either the same lender or a new lender.
- Take out a home equity line of credit (HELOC) on your property.
- Opt for a blended approach, in which your lender agrees to blend a new mortgage rate with your current rate.
Refinancing tends to be a popular way to boost your home equity because it usually comes with lower interest rates than taking out a second mortgage. While the rates for refinancing your mortgage will be higher than the current mortgage rates, they may still be lower than they were when you originally purchased your home. Refinancing can therefore save you money on interest over time and shorten the length of your amortization period.
Risks and costs to consider when refinancing
Can you afford the additional debt load and new payments that come with refinancing?
You read that right. You’ll have to pay most of the same closing costs you did when you first bought your home, including appraisal costs, origination fees, and legal fees. In addition, in order to qualify for mortgage refinancing, lenders want to see that you have a good credit score, a low debt-to-income ratio, and a fair amount of pre-existing equity in your home.
You may also face a large penalty from your lender if you break your mortgage term early. Depending on the lender, that could be around three months worth of interest or an interest rate differential, usually whichever of the two is higher. And if you’re switching lenders, you may have to pay a discharge fee. However, if you’re going to save thousands of dollars in interest by switching to a lower mortgage rate, paying those penalties may be worth it.
If the costs are more than your potential savings, however, it doesn’t make good financial sense to refinance. Just make sure you factor in all the fees before you decide if refinancing is right for you. Keep in mind, too, that if you want to switch lenders and your new lender is a bank, you may need to re-qualify for the mortgage stress test. Also, if you switch from a fixed-rate mortgage to a variable-rate mortgage, you may deal with rising interest rates and higher monthly payments in the future.
It’s best to speak with a mortgage professional to help you understand what your costs and options are when it comes to refinancing. Don’t wait until you receive the renewal letter from your lender to find a refinancing plan, either. Compare rates from multiple lenders and consider refinance offers long before the end of your mortgage term.
LowestRates.ca is a free and independent rate comparison website that allows Canadians to compare rates from 30+ providers for various financial products, such as mortgages, credit cards, and home and auto insurance.