I have been working with clients for years and have seen all sorts of different situations that clients are in. Sometimes a mortgage refinance is a good option. Sometimes a mortgage refinance isn't a good option.
Have you been thinking... "Is it worth it to refinance my mortgage?" Let's explore that question.
It may be worth it to refinance your mortgage if the benefits outweighs the cost. I have an 18-month rule of thumb. If you can cover the cost of the refinance within 18 months, then it's more likely to be a good idea. You will also want to consider your payments and cash flow as well as your long term plans.
I think that the best way to determine whether it's worth it or not to refinance your mortgage is to look at the different reasons that you may have to refinance your mortgage. Then you can have a framework to use for your own decision.
Top reasons to refinance your mortgage:
- Pay off debt
- lower the interest rate
- lower overall payments
- get equity out of your home
- renovate your home
- invest in something
As we review each of these reasons, you should get a good idea of what might be best for you. If you need help with making this decision, then I always recommend working with a mortgage broker. Your mortgage broker can help you to explore all the pros and cons.
Before we go into more detail, I want to define what I mean by refinancing your mortgage. A mortgage refinance is the process of paying out your existing mortgage by setting up a new mortgage for the same or higher amount.
There are other ways to get equity and cash out of your home by keeping your mortgage in place. I may touch on these a little, but I'm not going to comprehensively cover those options here.
I also want to cover some of the costs to refinance a mortgage because the costs will apply to all the options we will cover later.
What Will It Cost To Refinance My Home?
Whenever you set up a mortgage, there will be costs. A mortgage registered against your home's title and therefore a solicitor or notary or title company will charge a fee to do this. Let's review the costs for a mortgage refinance.
- Existing mortgage penalty
- mortgage discharge & registration costs
- appraisal fee
- lender fees
- broker fees
This could potentially be the biggest cost to refinance your current mortgage. When you set up a mortgage, you are signing a contract. If you break the contract before the end of the term, then your lender could charge you a penalty.
I wrote an article covering mortgage penalties, please review this article for more details. How do mortgage penalties work?
In brief, your lender may charge you a penalty if you break the mortgage early. The penalty will depend on the type of mortgage you have.
If you have an open mortgage, then there is likely no penalty. However, some banks do charge an "admin" fee if you break the open mortgage in the first few years. Check the fine print!
If you have a variable mortgage, then the penalty to break the mortgage is typically calculated as 3-months interest. Sometimes, it may be higher again depending on the contract. Some lenders offer "promotional pricing" on mortgages where the interest rate appears to be better upfront, but there are larger fees and penalties to break these contracts. Check the fine print!
If your mortgage is a closed fixed-rate mortgage, then you will be charged the greater of 3 months interest or the Interest Rate Differential (IRD) penalty. This could range from $1,000 to $12,000 or more. This penalty would depend on how the lender calculates the IRD.
In some cases, lenders offer a "promotional mortgage" where they are giving a slightly lower interest rate but higher fees and penalties to cancel before the end of the term. These mortgages are promoted as "low rate" or "no-frills" or "value" mortgages.
Each is a little different and have different rules regarding refinancing and paying out early. Again, check the fine print!
Discharge & Registration Fees
To set up a mortgage, the lender will want to register their interest against the title of your home. To do this, depending on the province you live in, you will have to use a solicitor or a notary or a title company.
The lender will often pass these costs to you, but sometimes the lender will pay them. It's worth asking.
The registration fees could include land title fees as well as professional fees for the company facilitating the mortgage registration. There may also be a mortgage admin fee if your lender uses a title company to facilitate the registration.
Depending on the province you live in the fees could vary. In Alberta, a solicitor would charge $1,200 to $1,500 to facilitate the mortgage refinance. This would include discharging and paying out the existing mortgage as well as registering the new mortgage.
If there is no change to the title, except the mortgage registration, then some lenders may process this through a title company. The title company could charge under $1,000 to discharge and register a new mortgage.
During the application process, your lender will want to know how much your home is worth. They will either request a desktop evaluation of your home or a full appraisal.
The desktop evaluation could cost $99 to $150. It's based on other sales in your area. This is usually done if you aren't financing up to 80% of the home's value but to a lower amount.
A full appraisal will cost $350 to $500 depending on the home value and location. An average home in a big city would be $350. A large home or an acreage out of town would cost more, up to $500.
Lender fees will only apply if you don't qualify with an "A" Lender, like a bank or Credit Union or a Trust Company or a Monoline Lender.
A Monoline is a lender that only deals in mortgages. Examples of Monolines are MCAP, Merix, Lendwise, RMG, First National
If your credit is bruised or your income is not confirm-able the way "A" lenders like, then the next option is to consider an alternative lender. These lenders will generally charge a fee for setting up a mortgage. Whether it's a purchase or a mortgage refinance, they will charge a fee.
A typical lender fee could range from 1% to 4% of the mortgage amount.
In general, your mortgage broker will not charge you a fee if you are approved by an "A" lender. The "A" lenders will pay your mortgage broker a professional fee for helping facilitate the mortgage.
If you set up your mortgage with an alternative lender, then a mortgage broker will likely charge a professional fee to help facilitate that mortgage.
A broker fee could range from1% to 4% of the mortgage amount.
Refinance Your Mortgage to Pay Off Debt
One of the most popular reasons to refinance your home mortgage is to pay off debt. Whether you are paying off credit cards or paying off loans or both, the main reason to refinance is for cash flow.
When you evaluate whether it's a good idea to pay off debt, the evaluation is based on your cash flow. The interest rates and penalties and costs certainly factor, but sometimes the cash flow outweighs all these other items.
Your first step is to evaluate the costs to refinance your mortgage. Add the mortgage penalty, the legal fees, appraisal fees, lenders fees (if applicable) and broker fees (if applicable). You should also add the interest costs for the debt that you plan to pay off.
I find that whey you pay off debt, if it's just a small amount of debt, then it's best to arrange a consolidation loan. There are little or no costs to arrange a loan and you can free up some cash flow this way.
If you have a large amount of debt, more than $50,000 is a good rule of thumb, then refinancing your mortgage would free up a lot of cash flow. The overall lower payments and lower interest costs could outweigh the costs of set up.
If the mortgage penalty is high, then a refinance may still be too expensive. In that case, it may be a good option to look at a second mortgage or a home equity line of credit.
A second mortgage will have higher interest rates and fees but may be necessary if your credit is bruised.
A home equity line of credit can be set up without paying out your existing mortgage. The interest rates are very good, you can often lock in a fixed interest rate rather than choosing an open variable interest rate.
For the home equity line of credit, you must have very good credit to qualify and this could offer better cash flow because you can choose interest only payments.
Refinance Your Mortgage To A Lower Your Mortgage Interest Rate
The main reason you would choose this would be to save money in the long term. I've found that by using the 18-month rule of thumb, you can come to a fairly clear decision wither or not it's worth it to refinance.
Basically, add up all the costs including mortgage penalty, legal fees and appraisal fees. Then add that amount to the mortgage. Compare the balance of the mortgage after 18-months against the original mortgage assuming you do nothing.
Let's use an example to illustrate this.
You have a mortgage of $350,000, your payment is $2,025/month and 20 years left.. Your interest rate is 3.5%, you have 3 years left. You have been offered 2.75% for 5 year term. The penalty is $3,063 to break your mortgage. Legal fees and appraisal fees will be $1,500. Is it worth it to break the mortgage early to get the lower rate?
Let's look at your current situation. Your mortgage balance is $350,000. After 18 months, the balance will be $331,331. At the end of the term (36 months), the balance will be $311,665.
If you choose to refinance for the lower rate, then your new starting balance today would be $354,563. Keeping the payments the same ($2025/mth), after 18 months, the balance will be $332,225. Let's also check after 36 months, the balance will be $308,954.
As you can see from this analysis. By refinancing the mortgage and keeping the payments the same, you do not recover the original cost of $4563 in 18 months. You do however recover the costs over the rest of the term. In fact, after 36 months, you are ahead by $2,711.
In my opinions, it probably worth it to do the refinance in this case because you do save over $2711 by the end of the original term. Another factor is the interest rate risk. After 3 years, if you did nothing, then you would have to renew your mortgage at prevailing rates. What if those rates are higher?
By renewing now, paying the penalty, you are securing a good interest rate for the next 5 years. You are also saving more than it costs you over the term. This example looks like a definite advantage to renew early.
Interest Rate Risk
The interest rate risk that I talk about earlier can apply to renewing into a lower rate. I can also apply to renewing into a higher rate. If you think that rates will start raising over the next few years. If might be better to renew early, even at a slightly higher interest rate. You can secure a good rate for a full 5 years.
In this example, if after 3 years, when your mortgage is ready to mature, the renewal rate is the same back to 3.50% again or higher, then you have lost out. It would actually have to be lower than 2.75 to compensate for the savings that you generated by renewing early.
If you think the rate will be higher, then it may be worth it to pay the penalty for the lower rate even if it takes a little longer than 18-months to return the initial costs.
It's important to review the numbers and make an informed decision!
Refinance Your Mortgage to Lower Overall Payments
In this situation you are looking to ease your cash flow. Whether the interest rate is higher or lower may not be a factor. When your goal is to lower your overall payments, then a refinance is a good option and the cost is less important.
What you should consider are the different options to refinance. When you break the mortgage, there is a penalty. If you have had your mortgage payments accelerated, some lenders will allow you to reduce the payment back to equal the original amortization. This could lower the payment without incurring a penalty.
If you have enough equity, another option could be to set up a Home Equity Line of Credit (HELOC) behind your current mortgage. When you set up a Home Equity Line Of Credit behind your mortgage, there is no payment.
You could use the HELOC to cover some of all of your payments until your mortgage is ready to mature. With the HELOC you only have to pay interest on the balance that is outstanding. You can use some of the balance of the HELOC to free up some cash flow for you.
This strategy will allow you time to wait until the mortgage matures, at which time you can pay it out without penalty and set up a mortgage with lower payments.
Refinance Your Mortgage to Get Equity Out of Your Home
When your goal is to get equity out, then the costs will depend on what you are using this "equity" for. If you plan to invest in something that will give you a greater return than the costs, then it might be worth it.
A cost comparison may of may not apply here. What I suggest in this case is to review the different options. A second mortgage would avoid the penalty, but would come with costs and a higher interest rate.
A HELOC, like I described in the last section could be an option. This would have a much better interest rate, interest only payments and you could pay if back without penalty if you got the money back in a short time.
There are many different reasons to get equity out. Your costs will depend on whether or not you qualify. If your credit is bruised, or you can't confirm income, then a second mortgage may be your only option. A second mortgage would come with costs.
Refinance Your Mortgage to Renovate Your Home
This is a reason that I hear all the time. Like the description that I made with the Equity out, the cost will depend on when you need the money. If you aren't in a hurry to renovate, then wait until the mortgage is ready to renew.
If the interest rates are good at this time, then you could get money out, save in the long run and complete your renovation. A win, win, win.
If your mortgage penalty is big, then a home equity line of credit could work better. This also gives you flexibility to draw funds as you need them. You will only pay interest as you need, instead of paying interest on all the whole amount of money up front.
There are a number of options here and it's best to get the full picture before you jump on just one thing.
Refinance Your Mortgage to Invest in Something
Here you are looking to make a positive return on investment, well at least most people are. Most of the time, I help clients set up a HELOC when they want to invest. The HELOC gives them more flexibility. You can separate the money you have invested from the other money you owe on your home.
It's easier for your accountant to attribute the interest on that portion to your investment and the interest on the other portion to your home, which you live in and is for personal use.
I have seen cases where we refinance the mortgage to invest, but in most cases a HELOC is the best option.
Like all the other options above, look at the costs. The mortgage penalty is usually the biggest cost. Legal fees and appraisal fees can also apply. You aren't likely to opt for a second mortgage or private mortgage because these costs are high and would eat into your potential return.
In some cases you may, but that decision is best reviewed and analyzed by you and your mortgage broker.
We have covered a lot here. We reviewed the costs to break a mortgage and to set up a new one. We discussed the different reasons that you may want to refinance your mortgage and whether or not it's worth it.
I have found that every client situation is a little different and you need to look at all the numbers, options and choices before you choose. You also want to review your reason for doing this. Your reason for refinancing your mortgage will help guide your decision.