We've talked about many benefits of a mortgage refinance and the reasons for applying to refinance your mortgage. Now, let's talk about when you can you refinance your (my) mortgage?
For a mortgage refinance, lender can only lend up to 80% of the value of your home. Therefore, you can refinance your mortgage when you have built up enough equity in your home. That is, your current mortgage balance is less than or equal to 80% of the home's value and you qualify to refinance your mortgage.
You might be able to refinance your mortgage now, but it might not be the right time. Let's review in more details how a mortgage refinance works and how to calculate how much you could qualify for.
This will give you a much better foundation to make your decision as to when is the right time.
How much of a mortgage refinance do I qualify for?
Qualifying for a mortgage refinance is based on two factors. First, the qualifying payments on your new mortgage refinance, including property tax costs, condo fees and heating your home, can not exceed 39% of your gross income. Second, you can only refinance up to a maximum of 80% of the value of your home.
Applying for a mortgage refinance is a little different than applying for a mortgage to purchase a home because of legislation. Most lenders in Canada are governed by OSFI (Office of the Superintendent of Financial Institutions) and are required to finance up to a maximum of 80% of the value of your home.
If you want to refinance your mortgage for more than 80% of the value of your home (called the Loan to Value ratio - LTV), then it's still possible, but you would have to apply with an alternate lender or a private lender.
Alternate lenders and private lenders are not governed by OSFI and can therefore provide financing for up to 85% or even 90% of the value of your home. If you wanted to opt for this type of financing, then I've written a couple of articles related to that.
- When To Consider A Second Mortgage?
- Requirements For Second Mortgages In Canada
- What Is A Home Equity Loan and How Does It Work?
For the purposes of this article, we will discuss refinancing your mortgage up to 80% of the value of your home's value.
How much can you borrow when refinancing your home?
OK, so we have already established that the maximum that you could qualify for is based on the lesser of either 80% of your home's value or and income based number. How do we calculate that income based number?
I created an income based calculator for home buyers to figure out how much purchase they could qualify for based on their income. You can use that calculator to get an idea how much you can qualify for. Click here to try the Income Based Mortgage Calculator.
This calculator will give you a good guess for the mortgage amount, but the qualification criteria is slightly different for conventional mortgages including mortgage refinances.
I will include this calculator here. Please note. Add your gross annual income. If you own the home with a partner or spouse combine both gross incomes (that is, income before income tax). Include your annual property tax cost and monthly condo fees. If you have loans or credit card balances or line of credit balances, then include those too.
Choose 20% down (basically, you can only finance up to 80% of the value of your home, therefore 20% is fine.
Once you have input these numbers, then look at the answers on the left side under "Qualifying Mortgage Amount".
Now that you can figure out how much you can borrow when refinancing your home.
The maximum you can borrow is the lesser of 80% of your home's value or the mortgage amount on the left side of the above calculator.
This calculation should give you a fairly good idea but you won't know the exact amount unless you apply with a lender. I would recommend that you speak with a mortgage broker. I (or a member of my team) would be happy to help.
When a lender does these calculations, they will want to order an appraisal to determine the current market value of your home. If your estimate of the value is low, then you could potentially get a larger mortgage amount. If you estimate of your home's value is high, then you may not get as much you calculated here.
It's also important for the lender (and your broker) to review your paperwork including income documents, credit report, etc. Let's talk a little bit about qualifying in the next section...
Do you qualify to refinance your mortgage?
To qualify for a mortgage, whether a refinance or a purchase, a lender will consider 3 factors:
- Your Credit
- Your Income
- Your Equity
These three factors help balance out the decision process that your bank will go through. I often think of this like a three legged stool. If one of the three is an issue, we can support with the other two.
There are 2 other factors in addition to these that lenders will also use to shore up the 3 legs of the stool. These two factors are your net worth and you that LTV (we introduced this earlier, that is, the loan-to-value).
If you have a credit score of 620 or higher, then you should qualify for a mortgage with most "A" lenders. An "A" lender would include all of the big banks in Canada, the credit unions and Monoline lenders.
If your credit score is under 600, then it's more likely that an "A" lender will not approve your application. There are Alternate lenders who would consider the mortgage refinance. They will also finance up to 80% of the value of your home.
If your credit score is under 500, you may not qualify with an alternate lender. Then we would look at options with private lenders. In this case, a refinance might not be a good idea. We'll talk about that later.
Your credit score can be affected by many different things. Most of the time, I see small issued (mistakes) with my client's credit, they aren't causing any issues. We often help the client to fix them when we notice them.
Some of these issues might be that a balance is showing up on a credit card or a loan that you had previously paid out and closed. Your address history might be incorrect. There might be a spelling error. There are a number of things.
You could check your credit, by ordering a report for yourself. Then you can fix these things, it's not really that important unless your score is getting close to or below 600.
If your credit is good, then you can wait until your broker pulls the report. Your broker can help you to get some of these errors fixed, if there are errors.
In the last section we touched on your income. Lenders have specificity calculations that they make to determine if you qualify for a mortgage. The guidelines suggest that no more than 39% of your income can be used toward the housing costs.
These housing costs will include principle and interest payments, property tax payments, condo fees (half of these, actually) and heating your home.
The guidelines also suggest that no more than 44% of your gross income can go toward your housing costs and all of your debt.
These guidelines that I am reviewing here are much more strict with a home purchase. When you refinance your home, lenders will be a little more lenient. Well, some lenders will.
Some lenders ("A" lender) will allow these numbers to be a little higher if things make sense.
If your numbers are too high and an "A" lender won't approve you, then there are alternate lenders. These alternate lenders are more lenient with credit, they are also more lenient with income. They might accept different forms of income that an "A" lender wouldn't consider.
When you are refinancing your home, there are many options and there are different ways to present your case to a lender to get you the best deal. That's why I generally recommend you speak with a broker...
To confirm your income, lenders will want to see documentation. Let's review that briefly...
- Letter of Employment
- Pay Stub
Variable Income or 2 Jobs or Overtime:
- Letter of Employment (all jobs)
- Recent Pay Stub (all jobs)
- 2 years of T4's
- 2 years of Notice of Assessments
Variable income type jobs are where you work overtime, or you receive bonuses, or you earn commission or you have 2 jobs. For these types of income, you need to provide 2 years of history so that the lender can average things out.
They want to have a fairly good idea of how much you are earning.
- 2 years T1Generals
- 2 years Notice of Assessments
- 2 years Financial Statements (if you own a corp)
For self-employed clients, most "A" lenders want to see a 2 year history of self-employment. Some will make exceptions if you've been in the same line of work or have other mitigating circumstances.
If you haven't been self employed long then an alternate lender may be a better option for a mortgage refinance. In this case, look at your options. A second mortgage might be better. Work the numbers.
Talk to a broker who works with both "A" and alternate lenders to see where things might be best for you.
The equity in your home is one of the key factors to calculate how much you can set up the mortgage refinance for. With an "A" lender or Alternate lender 80% is the max.
If you have challenges with your credit or if your income isn't strong, then the "A" lender might cut back their approval from 80% to 75% or 65% of your home's value.
Lenders want to find a way to get you the financing you are looking for. If they can't approve your request at 80% but they can work things out for 75% then these lenders will typically provide this option.
Different "A" lenders will make different exceptions and will look at different types of income differently. If you just go to one bank yourself, and they cut back the approval to a lower amount. You won't know if you would be approved with another "A" lender.
I feel like I'm pushing this too much, but it's really important to chat with a mortgage broker. You will get better selection of options and your broker can give you insight into what different banks are looking for and which is better depending on different situations.
Now that we've talked about qualifying for the mortgage refinance and some of the details about credit and income and the equity you have in your home, let's look at some examples.
How much money can you take out on a refinance?
When clients ask to refinance their home, most of the time they are looking to get cash out. In Canada, I don't hear clients say "cash out refinance" too much, I think that's a term used in the US but the gist of it is correct.
You want to get cash out of your home when you refinance. Makes sense and that's what you are doing.
To calculate how much cash you are getting out of your mortgage refinance, let's look at a couple of examples.
Client Example: $500,000 home, $100,000 first mortgage, $400,000 equity in the home
For this section, I'm not going to talk about income to qualify or any other complications. I'm just going to calculate how much cash out that this client will get.
First, we calculate 80% of the home's value. $500,000 x 80% is $400,000
Next, we subtract the mortgage balance from 80% of the home's value, $400,000 minus $100,000 equals $300,000. Therefore this client would receive $300,000 cash out for the mortgage refinance.
Some client will think that they will receive 80% of the equity but that calculation is incorrect. The correct calculation is to calculate 80% of the home's value then subtract the current mortgage balance.
Client Example: $350,000 home, $150,000 mortgage
First we calculate 80% of the homes value. That is, $350,000 x 80%, equals $280,000. Then we subtract the mortgage, $280,000 minus $150,000 equals $130,000.
In this example, this client would receive $130,000 cash out.
Client Example: $400,000 home value, $300,000 mortgage balance
To calculate the cash out, we first calculate 80% of the homes value. $400,000 multiplied by 80% is $320,000. Then we subtract the mortgage balance, $320,000 minus $300,000 equals $20,000.
In this case, the client would receive $20,000 cash out. For this example, it might not be worth it to refinance the mortgage. There isn't too much cash out and we haven't factored in costs.
I wrote an article about how to figure out if it's worth it to refinance your mortgage or not. Check that out for more details.
Why would you not want to refinance your mortgage?
As I just mentioned, sometimes it's not worth it to refinance your home. The article I wrote called "Is it worth it to refinance my mortgage" covers this topic quite comprehensively (I think).
Let me give my rule of thumb. When you are reviewing your options for a mortgage refinance or a home equity line of credit (you should always consider this as an option!) or another option. Ask yourself...
Will I be better off financially?
In the third client example above, the cash out was calculated as $20,000. There could be a penalty to pay out the current mortgage, there will be legal fees and an appraisal fee.
For $20,000, it might be better to just apply for a personal loan or an unsecured line of credit.
You might consider applying for a Home Equity Line of Credit (HELOC). Most lenders will require a minimum of $50,000 for a HELOC.
In this example, you could potentially set up a HELOC for $50,000.
I hope you were just yelling at me... "but Steve, I though you said that lenders can only finance 80% of the value?"
Yes, that's true. However, what we can do in this case is set up a $50,000 HELOC, then use $30,000 of the available funds from the HELOC to pay down the first mortgage.
The client would start out with a mortgage of $300,000. After we set up the new HELOC, the client has a mortgage of $270,000 and a HELOC with a limit of $50,000 and a balance outstanding of $30,000. This client would then have access to an additional $20,000.
This client could also pay down this debt or pay it off and have the HELOC available for the future.
The answer to that question, "Will I be better off financially?" is really important. Have your mortgage broker review the numbers with you.
Make sure you are making a decision that is right for your situation and moving you forward financially.
What costs should I expect to refinance my mortgage?
There are several expenses that you would expect from every mortgage refinance:
- Appraisal Fee (approximately $350, may be more depending on the location of your property)
- Legal Fees (this varies from province to province, ranges from $1,000 to $2,000)
- Mortgage Penalty (this could be the biggest cost)
Sometimes a lender might use a desktop appraisal (meaning, they don't visit your home) to determine the value. There is a lower cost for the desktop appraisal but there will be some sort of fee to determine your home's value.
When you refinance your mortgage, the lender will be discharging the existing first mortgage and setting up a new one. A solicitor, or notary (in some provinces) will complete this for the lender.
Some lenders will also utilize the services of a title company to do this. Often the title company is a little less expensive than a solicitor. Your mortgage broker would let you know the options in your situation.
Finally, the mortgage penalty. This could be huge or it could be just 3 months interest. I wrote an article about mortgage penalties, read this article for more insight into how penalties are calculated.
If you refinance your mortgage during the term, then your lender will charge a penalty unless the mortgage open.
If you refinance your mortgage at the end of the term, then it is open and can be paid out in full without penalty. Many clients that I work with will choose to wait until the end of the term to refinance their mortgage.
That way, they don't have to pay a penalty to break the mortgage early.
I have a calculator that I created that you can use to make those calculations for yourself. You can find this calculator on my website here. Why should you refinance your mortgage?
This calculator allows you to compare 2 different mortgages. Add the penalty to one side and compare interest rates and payments, etc. I use it all the time when client's want to figure out what might be better.
When we started, we talked about "how much mortgage refinance can I qualify for?" That number is based on two calculations. One based on your income and the other based on your homes value.
You can then compare those calculations. The calculation that is lower, is your answer. You will also note that lending practices are a little more lenient when refinancing your mortgage. Therefore, don't just use the calculations on this page and end things there.
If you do want to complete a mortgage refinance, then also speak with a mortgage broker. The numbers that you have calculated here will provide you with a very good guess. However, base your decision after you have spoken with a professional.
If you have questions, or think that I should include additional information here, please connect with me. Visit our "About Us" page to connect with me (Steve) or a member of my team.