I have been helping clients with their mortgages for many years. Sometimes I suggest they consider refinancing their mortgage. Other clients will ask me, "should you refinance your home?" or "should you refinance your mortgage?"
The main reason you should refinance your home mortgage would be to put yourself into a better financial position. You might have an opportunity to reduce the interest you pay. You could do it to increase your cash flow. You might want some cash out of your home. It's important to make sure the benefits outweigh the costs.
Let's take a look at some different situations where it might be a good idea or a bad idea. Let's also review some questions that you might ask yourself to make sure it's right for you.
Before I review the reasons that you would refinance your home mortgage, let's take a look at the potential costs to refinance your home:
- Legal Fees
- Appraisal Fees
- Penalty to break the current mortgage
- Lenders Fees
Legal Fees: The legal fees to refinance your home mortgage will vary slightly from province to province. They could range from $500 to $1,500.
Some lenders will use title companies and these fees are on the lower end. Using a lawyer will cost more than using a title company.
Appraisal Fees: An appraisal will cost close to $300 to $400. If you have a large home or you live on an acreage or far from a large city, then the appraisal could be $750 to $1,000.
Some lenders will complete an electronic analysis before ordering the appraisal. Each lender will use different factors for this analysis. An appraisal can be waived if the value determined by their electronic analysis is sufficient for the mortgage amount you are requesting.
The lender must determine the value to provide financing to you. When you refinance your home, lenders can only finance up to 80% of your home's value.
Either an electronic analysis or an appraisal will be used to determine how much they can lend to you.
Penalty to break the current mortgage: If you pay out your current mortgage during the term, that is, before the end of the contract, then the bank will charge a penalty.
Before you refinance your mortgage, you will want to know what the penalty is. Sometimes this penalty is just too big and it's not worth it to pay that penalty to refinance.
You can avoid the penalty by waiting until the end of the term. When your mortgage matures, then it's open. There is no penalty to pay it out.
Another way to avoid the penalty is to blend your current rate and term with today's rates. Some lenders are more flexible with this option than others. Most of the time, if you blend your current mortgage during a mortgage refinance, then the lender doesn't offer the best rates.
They know you will have to pay a penalty to go to another lender, so they don't have to be too competitive.
A mortgage penalty could range from $1,000 to $15,000. Make sure you get this number before you start. If your penalty is over $5k, then there are other options to consider instead of refinancing your home.
It's also important to know if you are allowed to refinance and payout your mortgage early. Some mortgage contracts don't allow you to do that.
Lender Fees: If you have good credit and are going through the process to refinance your home mortgage, there aren't going to be extra lender fees.
If you have bad credit or issues confirming your income, then you may have to work with an alternate lender. In this case, you may pay an additional lender fee ranging from 1% to 2% of the mortgage amount.
As you begin the process, your mortgage broker will let you know what to expect and whether or not to expect a lender fee.
Why Might You Want To Refinance Your Mortgage?
- To consolidate credit cards or other debt.
- To reduce your payments
- To reduce your mortgage interest rate
- To get equity out of your home to purchase something
- To Invest, catch up on RSP contributions
- To Invest, purchase a rental property
Should You Refinance Your Home to Consolidate Debt?
I listed this as the first for a reason. Things happen and sometimes we use credit cards and lines of credit to maintain a lifestyle or to cover unexpected expenses. Once the debt starts to rise, it can be tough to get it under control.
From my experience, clients refinance their home mortgage to pay off credit cards and loans and to consolidate debt.
The first question to ask your self is why. That is, what do you want to accomplish by doing this? Do you want to reduce your payments? Do you want to reduce interest costs? Is there another reason?
By answering why you are considering a mortgage refinance, you can then evaluate whether it's worth it or not.
We already talked about the costs. You will pay at least $1,000 to complete this process, assuming there is no penalty or lender fee. Are you going to save this cost over the next 12 to 18 months? Are you going to be in a better financial position after?
From my experience, if you are in a better financial position and you can recover the costs over the next 12 to 18 months, then it's worth it to refinance your home mortgage for debt consolidation.
I have met clients who were struggling financially. Things happened in their lives, both spouses had to take pay cuts due to the economy. The debt started to build because the didn't have the same net income as they had in the past.
For these clients, we refinanced their home, paid off all their credit cards and also gave them an additional $20,000 cash to keep separate as an emergency fund. Their mortgage payments were lower than after the refinance and now the didn't have any other debt payments.
For these clients, the benefits far outweighed the cost. They paid a penalty to get out of the mortgage (it was only $2,600), so their total cost was close to $4,000. They felt so much relief after everything was done.
These clients came to me in time. They were close to the max on all their credit cards but none had been paid late. Their credit was still good.
Overall their payments were reduced by $1,100 per month. Now they could afford every month. They could start saving again and build their retirement savings.
Should You Refinance Your Mortgage to Reduce Your Payments?
This reason to refinance your home is similar to consolidate debt but is slightly different. When I help clients decide whether they should refinance their home mortgage to reduce payments, I review the pros and cons.
I also talk to them to make sure that "reduced payments" is, in fact, their goal. Sometimes people tell me that they want to reduce payments, but after asking more questions, they are planning a purchase or one of them is making a change to their employment that could affect their income.
Therefore, the first thing you must do is decide why you want to do this. What are your future plans and why will refinancing your mortgage to reduce your payments help you accomplish these plans?
It might be better to set up a Home Equity Line of Credit instead of a mortgage refinance. It might be a great idea to refinance your home mortgage if you plan to leave your job in a few months to go out on your own. It's much easier to qualify for a mortgage when you are working and have guaranteed income.
Once you have reviewed your goals, then evaluate the costs. The legal fees and appraisal fees will likely be at least $1,000. Will there be a penalty? If so, how much would that penalty be?
Now, ask yourself... Is it worth it to pay these costs to reduce my payments by $300/month (or whatever number)?
In most cases, when clients call me to help them reduce their payments, they are planning to make an income change in the future. They may be retiring or semi-retiring. They could be setting up their own company.
If that's what you are thinking, then planning early while providing the best benefit. I would suggest that you consider a mortgage and line of credit combination.
When there is change on the horizon, we don't always anticipate every possible situation. By setting up a mortgage and line of credit combination, you can reduce your mortgage payments by extending your amortization.
You can also give yourself access to some of the equity in your home without having to pay interest on what isn't being used. I like the flexibility available when you do this option.
If you are going to pay the costs to refinance your home, there aren't any extra costs to set up a line of credit at the same time.
If you are in this situation, connect with us and we can review your options. I have many self-employed clients who have a home equity line of credit in place for emergencies. It's always one of the lowest rates available for an open and flexible product.
Should You Refinance Your Home to Reduce Your Mortgage Rate?
When interest rates are moving down, many clients will ask if it's worth it to refinance their home mortgage to reduce the interest rate. I have a rule of thumb that I use. If you can recover all the costs including the penalty in 18 months or less, then it's worth it.
To calculate these savings, I first calculate the mortgage, as of today, without any changes and check the balance after 12 months and after 18 months and also after 24 months.
I then calculate the new mortgage, the current mortgage balance plus the costs, at the lower interest rate and check the balances at the same intervals. That is, after 12 months, 18months and after 24 months.
I make also compare the payments and try to keep the payments the same, if possible. If not, I also have to factor the payment difference into the calculation.
Once you run that calculation, it's fairly easy to tell if it's worth it or not to refinance your home mortgage.
I would like to make one observation. In some cases, it could be worth it, even if you don't recover your costs within 18 to 24 months.
If interest rates are expected to rise, you can pay out a mortgage with a short term remaining and lock in for a longer-term, you are protecting your interest rate for a longer time frame.
I have had situations where the benefit was more than 24 months, but the client was happy to lock in a lower interest rate for an additional 5 years. They avoided the risk of interest rates being much higher when the current mortgage matured in just 30 months.
Is it worth refinancing my mortgage for 0.5 percent or 1 percent?
Clients will ask if it's worth refinancing my mortgage for a certain percentage. I like to use the calculation that I described above. This way you can evaluate the costs versus the savings directly. You can also evaluate your goal.
I built a calculator that will do these calculations for you. If you have questions about how this works, connect with us and we are happy to review the details.
Complete the calculation yourself....
Should You Refinance Your Mortgage to Get Equity Out of Your Home (Purchase Something)?
As you pay off your mortgage you build up equity. It can be nice to get access to some of this for a major purchase. If you want to purchase something big, it might be a good idea to refinance your home mortgage to get equity out, but it might not.
Always evaluate your ultimate goal and in this case your other options. When you refinance your home, you will be offered much better rates than with most other loans. You can also choose an amortization up to 25 or 30 years, which keeps the payments low. However, there are costs. Compare and contrast this with financing available for that something you wish to purchase.
If you are buying an RV or vehicle, then it might not be better. RV financing could be amortized over 15 or 20 years, keeping the payments low. Many dealers have very competitive rates, close to mortgage rates. RV loans don't have legal and appraisal fees.
Vehicles can be amortized up to 7 or 8 years. There aren't legal or appraisal fees. The payment will be bigger than a mortgage payment, but do you want to be paying for a vehicle much more than 7 or 8 years anyway?
If you are purchasing something that isn't readily financed as an RV or vehicle, then refinancing your home or setting up a home equity line of credit could be a better option.
As you can see from some of my answers above, I like to help clients explore different options. Sometimes a Home Equity Line of Credit is the best solution. Sometimes you should refinance your home mortgage. Sometimes a personal loan is the best option.
The answer depends on you, your goals and your current financial situation.
Should You Refinance Your Home to Invest, Catch Up On RSP Contributions?
As you build equity in your home, I have many clients who want to leverage that equity to increase their wealth. There are several things you could invest in, including your Registered Retirement Savings Plans (RRSP's).
If you are going to take equity out to invest in something other than an RRSP, then I would recommend a Home Equity Line of Credit rather than refinancing your home mortgage. The reason I suggest this is for tracking purposes.
When you set up a Home Equity Line of Credit, you can track all the interest that is charged on that account over the year. A Line of Credit can help you to keep the money you are using for investments separate from the money you own on your home that's personal debt.
If you only use the Line of Credit for investment purposes, then you can write off the interest against the investment. (Note, I am not your accountant. You should check with your accountant and tax professionals before acting on advice here.)
If you are investing in your Retirement Savings, through an RSP, then that loan is not tax-deductible. (Note, check with your accountant). If the money doesn't need to be kept separate, then it's perfectly fine to either refinance your home or set up a home equity line of credit.
The first step in evaluating what's best for you is to consider your goals and to consider the options available. For an RRSP contribution, many lenders will offer RSP catch up loans at very low-interest rates with amortizations up to 15 years.
RRSP "catch up" loans do not have set up costs like a mortgage does. The rates are good. The amortization is long, therefore, payments are low.
Unless you have more goals, like pay off debt too, or something else, then there's no clear winner to choose an RSP loan or mortgage refinance.
Should You Refinance Your Mortgage to Invest, Purchase A Rental Property?
This is the second most popular reason to refinance your mortgage. I have many clients who either want to purchase an investment (rental) property or want to purchase a vacation home.
There are 2 options to consider when financing a rental property. You can refinance your home or you can set up a home equity line of credit. When you refinance your home, then you are mingling investment debt with personal debt. This can be hard for your accountant to sort out when you file an annual income tax.
A home equity line of credit can keep the personal debt and investment debt separate. The best option for accessing equity to invest in the home equity line of credit. However, sometimes this is not possible (for a multitude of reasons).
If you don't qualify for a home equity line of credit for some reason, then the next best option is to refinance your home mortgage to invest in a rental property.
Is Refinancing My Mortgage Worth It?
We have looked at 6 different reasons that you might want to consider refinancing your home mortgage. In every situation, you first want to figure out your goal and compare other available options.
Based on your goal and comparing all the options that are available to you, then you will clearly know whether it's worth it or not. In some situations, it is, in others, it isn't.
If you aren't sure, connect with us and we can talk through your options and review the numbers so that you can make an informed decision.