Refinancing a Mortgage in Canada is a financial strategy that homeowners may consider for a wide variety of reasons.

By refinancing, individuals can replace their existing mortgage with a new one, often with different terms and conditions that better suit their current financial situation. 

This process can result in a lower interest rate, reduced monthly payments, or access to equity built up in the property.

The decision to refinance is not always a slam dunk, however. In this article, we explore the intricacies of mortgage refinancing to determine whether it's the path you want to take.

As always, homeowners should conduct thorough research or consult a financial advisor to understand the implications of refinancing their mortgage.

What is mortgage refinancing in Canada?

Refinancing a mortgage involves renegotiating the terms and conditions of an existing mortgage contract. 

You'd end up doing this with the intention to either lower your overall interest rate or possibly access the equity inside of the home via something like a Home Equity Line of Credit (HELOC).

What exactly is refinancing?

Refinancing is the process of paying off an existing mortgage with a new loan, either with the current lender or a different financial institution. The new mortgage comes with terms, interest rates, and amortization periods, which can differ from the original mortgage arrangements.

Why would someone refinance their mortgage?

There are several reasons why one might choose to refinance, including:

• To Secure a Lower Interest Rate: If mortgage rates have dropped since the original mortgage was removed, refinancing to a lower interest rate can reduce monthly payments.
• To Access Equity: Homeowners often refinance to borrow against the equity they've got in their property. This equity can be used for home improvements, debt consolidation, or other significant expenses. You often call this a Home Equity Line of Credit, or HELOC.
• To Adjust the Mortgage Term: Refinancing can extend or shorten the mortgage term, affecting both the amortization schedule and the amount of interest paid over the life of the mortgage.

What are the steps to refinance a mortgage in Canada?

The refinancing process in Canada typically includes several steps:

1. Property Appraisal: Lenders often require a current appraisal to determine the property's Mortgage Application: Homeowners must apply for the new mortgage, providing financial information and consent to credit checks.
2. Review of Mortgage Contract: The terms of the new mortgage, including interest rate, mortgage term, and repayment schedule, are examined and negotiated.
3. Cost Assessment: Refinancing may involve fees, such as legal fees, appraisal fees, and possible penalties for breaking the original mortgage contract early.
4. Approval and Funding: Once approved, the new mortgage funds pay off the existing mortgage. Any excess funds are disbursed to the homeowner if equity is being accessed.

Mortgage refinancing is regulated in Canada, with particular laws and practices pertaining to it. 

I suggest you consult a financial advisor or mortgage specialist to understand all aspects of refinancing your mortgage. It is certainly not a decision that should be made without extensive thought.

Evaluating your current mortgage to determine whether you should refinance

When considering refinancing, homeowners must closely examine their current mortgage. This includes an appraisal of the existing terms and interest rates and an understanding of how the Interest Rate Differential (IRD) might affect refinancing.

Assessing mortgage terms and conditions

You must look at your previous mortgage to determine whether it is worth refinancing. A mortgage with a high buyout penalty can quickly squash any aspirations to refinance, as the costs can be sky-high and not worth the reduction in interest rate.

Ask yourself:

• What is the duration of my mortgage term?
• Are there any fees or penalties for early repayment?
• What obligations and rights are outlined in the current mortgage?

If your mortgage terms are flexible enough that refinancing makes sense, you can start to consider your IRD.

Interest Rate Differential (IRD)

The IRD is a key consideration when refinancing a mortgage. It's the difference between the existing mortgage rate and the current available rates. 

If the current mortgage rates are significantly lower, the cost savings over time might justify the penalties incurred for breaking the existing mortgage.

However, if current rates are not much lower and you find that the buyout penalty will cost you practically all or even more than you're to save by refinancing, it doesn't make sense to do so.

Mortgage type and rates

The mortgage type—whether it's a fit's-rate, variable-rate, or adjustable-rate mortgage—influences refinancing decisions. 

If you are currently on a fixed rate and refinancing only makes sense on a variable rate mortgage, just understand that this completely changes the structure of your mortgages and adds additional risk when it comes to fluctuating payments.

If you're from variable to fixed, just know that you are locking in payment when you refinance, and a reduction in interest rates will no longer benefit you, whereas it would have with a variable.

It is critical that you determine what type of mortgage you're looking to get, as this will typically determine the financial benefits (if any) of refinancing.

Calculating your savings

When considering refinancing a mortgage in Canada, homeowners must carefully calculate the costs and weigh them against the savings to figure out if it is worth it.

Use a simple mortgage refinance calculator

A mortgage refinance calculator is an easy tool for homeowners seeking to renegotiate their mortgage terms. 

By inputting specific details, such as their current mortgage balance, interest rates, and remaining amortization, they can obtain an estimate of the costs associated with refinancing and the potential savings.

Some costs you can expect to pay

Refinancing a mortgage has quite a few costs. Although some of these are small in nature relative to the value of your home, they still exist. Here is a basic list of some costs you can probably expect to incur with every refinancing, but are certainly not the only possible costs:

• Penalty Fees: For breaking the current mortgage contract. These can be a significant expense, often calculated as the greater of three months' interest or the interest rate differential (IRD). They'll generally be more flexible on a variable rate than a fixed-rate mortgage.
• Legal Fees: Required for processing the new mortgage agreement.
• Appraisal Fees: To determine the current value of the property.
• Administrative Costs: Various additional charges by the lender or third parties.

Figure out how much you are interest

Homeowners need to compare the current interest rates of their mortgages against the rates available in the market. If the available rates are significantly lower, the cumulative savings on interest could justify the costs involved in refinancing.

If the monthly savings on the mortgage payment make the buyout penalty worth it, then the potential for interest savings is a compelling reason to refinance a mortgage. That is precisely why most people do it.

Securing a lower interest rate reduces monthly mortgage payments and the total cost of the loan over time. 

A more in-depth look at penalties and fees

Knowing the penalties and fees is an absolute must. If you don't, you end up refinancing thinking you're money when, in reality, it costs you money.

Prepayment penalties

Prepayment penalties are charges that lenders apply when a mortgage is paid off before the end of its term. 

This fee compensates the lender for the interest payments they will miss out on. The penalty is typically greater than three months or an interest rate differential (IRD).

The IRD is a complex calculation that considers the difference between the original mortgage rate and the current rate for a mortgage term that matches the remaining period of the original mortgage.

Generally, fixed-rate mortgages have higher penalties than variable-rate mortgages. However, buyout penalties are all mortgage-specific, so it's important to understand your overall terms.

Discharge fees and legal costs

Discharge fees may apply when one pays off and closes a mortgage. These fees cover the administrative costs of removing the mortgage from the property title. In addition, borrowers encounter legal fees during refinancing, typically between $1000-$2000, covering the lawyer's facilitating the financial transaction.

In some rare situations, the lender is willing to pay the fees, but I wouldn't do it.

A tip - Negotiate with your lender

Borrowers have the option to negotiate with lenders for better terms or to have some fees waived. It's essential to understand the details of the current mortgage contract to identify potential areas for negotiation. 

One can often negotiate the terms of prepayment penalties or seek a reduction in various administrative charges. 

Generally, these lenders have a large legal advantage over you as you enter into a contract. However, reaching out and trying to get better terms never hurts.

Choose the type of refinancing you want

When considering refinancing a mortgage in Canada, homeowners have several options. Each one of these options caters to homeowners who need a little something different.

Swapping from one mortgage to another

Refinancing into a fixed-rate mortgage allows a homeowner to lock in an interest rate for the duration of the loan, providing predictable monthly payments. This is particularly advantageous when rates are low and expected to rise. 

In contrast, a variable-rate mortgage adjusts the interest rate based on market conditions, which can lead to fluctuating payments. This can be good in a high-rate environment when rates are expected to come down.

Ultimately, refinancing from one rate to the other is popular among Canadians.

Cash-out refinancing

A cash-out refinance involves replacing an existing mortgage with a new loan for more than the homeowner owes on their home, with the difference being paid in cash. 

This option can be used to consolidate high-interest debt, fund large expenses, or invest in property upgrades. It often results in a larger loan amount and may affect the mortgage rate and payment schedule.

Home Equity Line of Credit (HELOC)

A Home Equity Line of Credit (HELOC) provides flexibility, allowing homeowners to borrow against the equity in their home. 

It typically has a variable interest rate and functions like a revolving line of credit, meaning homeowners can withdraw funds up to a certain limit, pay them back, and borrow again. This option can be ideal for ongoing expenses, such as tuition or home improvement projects.

Figuring out if you're suitable for refinancing

Unfortunately, you can't just decide to refinance your mortgage and make it so. The process is much like qualifying for your initial mortgage.

Your credit score must be good

A borrower's credit score is vital to qualifying for mortgage refinancing. Lenders typically look for a credit score that is considered "good," which generally means a score above 660. 

This threshold, however, can be higher depending on the lenders. A good credit score suggests that the borrower is reliable and less risky to lend to. Maintaining a strong credit score is crucial for those looking to refinance a mortgage.

If your credit score is sub-optimal, you could look to a B-grade or more lenient lender for money. Just know that you'll pay a higher rate of interest.

Your home must be of value, and you must have equity

To qualify for refinancing, homeowners must have sufficient home equity. Equity represents the portion of the property that the homeowner truly owns – it's the rent value of the home minus any outstanding mortgage balance. 

Typically, lenders require a minimum of 20% equity to approve a refinance application. A professional home appraisal is often required to assess the property's current value and determine the available equity.

You must pass the stress test

The mortgage stress test is a requirement for all refinanced mortgages in Canada. This test assures lenders that the borrower can manage interest rates higher than the current rate. 

Even for uninsured mortgages, where the borrower has more than a 20% down payment, the stress test is applicable. Borrowers must qualify at their contract rate plus two percentage points, or 5.25%, whichever is higher. 

The stress test accounts for the potential fluctuation in income, debts, and economic conditions, ensuring borrowers can continue payments even under financial pressure.

Popular reasons to be denied mortgage refinancing

Refinancing a mortgage in Canada can be denied for various reasons. Lenders assess each application with a fine-toothed comb, and even small discrepancies can lead to denial. 

Credit Issues: A low credit score is a prominent barrier. Lenders rely heavily on credit history, and bad credit suggests a higher risk to the lender.

High Debt Levels: The debt-to-income ratio is crucial. This measures the proportion of income that goes towards debt repayment. Lenders may question one's ability to take on more debt if one's level is too high.

Property Value Concern: A drop in the home's value affects the loan-to-value ratio, making refinancing unviable. Lenders want assurance that the proper property qualifies for the loan amount.

Incomplete or Inaccurate Application: Lenders need an application that is clear and accurate. Missing or false information may result in a denial. It's important to double-check all details before submission.

Lenders: Not all lenders have the same criteria. Specific internal guidelines and policies could also be the basis for a denied refinancing application. Each institution has unique strategies for assessing risk and may consider different factors when evaluating an application.

Popular refinancing strategies

Blend and extend options

A blend and extend option allows borrowers to renegotiate their mortgage before the end of their term. Essentially, they can combine ("blend") "their" existing mortgage rate with a new rate offered by their lender and extend the term of the mortgage.

This strategy is beneficial when favourable interest rates can lead to lower overall interest costs.

Pros:

• Potentially lower interest rates than the current mortgage.
• Avoids the cost of breaking a mortgage.

Cons:

• May result in higher rates compared to completely refinancing with a new lender.
• Could extend the time it takes to pay off the mortgage.

Breaking versus renewal

Deciding whether to 'break'' mortgage for refinancing or to renew with the current lender is critical.

Breaking a mortgage typically incurs a penalty, but considering if the long-term savings from lower rates outweigh these immediate costs may be worth considering.

Pros of Breaking:

• Access to lower interest rates if they have dropped significantly.
• Ability to renegotiate terms and conditions of the mortgage contract.

Cons of Breaking:

• Penalties can be substantial, depending on the mortgage balance and terms.
• Possible legal and administrative fees.

Using refinancing to consolidate debt

Through refinancing, homeowners can combine multiple debts into a single mortgage payment. This tactic may result in reduced interest rates compared to high-interest debts like credit cards, leading to potential savings on interest payments over time.

The consolidation of debt simplifies the repayment process since there is only one payment to manage. This can improve financial organization and make budgeting easier as well.

• Simplified Payments: A single monthly payment instead of multiple debt payments.
• Potential Interest Savings: Lower mortgage rates can translate to less paid over the life of the debt.

A warning - Debt consolidation is not black and white

It's crucial to consider the risks associated with this strategy.

Extending the repayment period of short-term debts across a long-term mortgage can result in paying more interest overall despite the lower rate.

There are also fees associated with refinancing, such as appraisal fees and legal costs, which should be weighed against the potential benefits of the consolidation.

• Increased Total Interest: Long-term payment may cost more in interest.
• Upfront Costs: Refinancing fees could offset the financial benefits of consolidation.

How often can you refinance your mortgage in Canada?

There are no legal limits on the frequency of refinancing a mortgage. However, practical considerations and terms set by lenders often dictate the timeline for when one may reasonably pursue refinancing.

Here are some factors that influence the refinancing timeline:

• Prepayment Penalties: Many mortgages come with prepayment penalties that can make it expensive to refinance too soon. The penalties often decrease over time, so homeowners might wait to avoid or minimize these costs.
• Equity Requirements: Borrowers typically need to have at least 20% equity in their home to qualify for refinancing. Building up this equity through regular mortgage payments and property value increases might take several years.
• Rate Fluctuations: When interest rates drop notably, it may be beneficial to refinance. Homeowners often consider refinancing if rates decrease by a significant margin, such as 0.75% lower than current mortgage rates.
• Lender Specifics: Mortgage lenders may have internal guidelines that restrict how soon you can refinance after obtaining a new mortgage or the last refinance.

How much can you refinance your home for in Canada?

In Canada, homeowners have the option to refinance their mortgage up to a certain limit.

Generally, one can borrow up to 80% of the appraised value of their home minus the remaining balance on their existing mortgage.

Here's a breakdown:

• Appraised Home Value: This is the current market value of a homeowner, as determined by a professional appraisal.
• Maximum Loanable Amount: Up to 80% of the appraised value.
• Existing Mortgage Balance: The amount still owed on the current mortgage.
• The difference between 80% of the homes and the current mortgage balance represents the maximum additional amount a homeowner can typically refinance.

What are the benefits of remortgaging?

First and foremost, lower interest rates are often the driving force behind remortgage decisions. Homeowners may secure a new mortgage with a reduced rate, potentially saving thousands over the life of the loan.

Another key benefit is gaining access to home equity. As homeowners pay down their mortgage, equity builds up.

Individuals may release some of this equity by remortgaging to cover major expenses such as home renovations or to consolidate higher-interest debts.

Additionally, remortgaging can provide more flexible mortgage terms, allowing homeowners to adjust the length of their mortgage or switch between a fixed and variable rate depending on their financial goals and market conditions.

Before remortgaging, homeowners must weigh closing costs and penalties for breaking an existing mortgage against the benefits.