When you own real estate, specifically your home, you have equity in your home. Home equity is essentially the amount of money you’ve already paid towards your mortgage loan. Or, the difference between your home’s value and the remaining amount of money left to pay off your mortgage. There are a few ways to realize equity in your home, and one of them is to refinance your mortgage. However, refinancing your mortgage isn’t a decision you should take lightly.
How does refinancing work?
Refinancing your mortgage entails breaking your existing mortgage loan and obtaining a new mortgage. Then, you use the money from the new mortgage loan to pay off your old mortgage. Upon refinancing, you might be subject to more favourable interest rates and different loan terms from either the same or a different lender.
Reasons to refinance your home
There are many reasons why you might consider refinancing your home:
Access Home Equity
Accessing or realizing equity in your home is possible with refinancing your mortgage. Another way to access home equity is by choosing a mortgage that offers a home equity loan or home equity line of credit (HELOC). This might be a less costly choice, since you don’t need to pay excess fees to use this loan, apart from a modest interest rate. However, if you don’t have access to a HELOC, you can access equity through refinancing your mortgage.
Realizing equity can help you pay for expensive obligations and wishes, such as:
- Renovating your home
- Investing in more property
- Paying expensive medical bills
- Covering post-secondary school tuition
- Funding a startup or business
- Pay off a higher-interest personal loan
Keep in mind, however, that to realize home equity, the refinancing option you’d be selecting is a “cash-out refinance.” This can cost you a higher interest rate on your new mortgage loan.
Secure a Lower Interest Rate
Securing a lower interest rate is a common goal for people refinancing their mortgage. Mortgage rates change over time and with the market. For example, mortgage rates in Canada are low right now during the COVID-19 pandemic, with some lenders offering record low rates of 1.99%. However, if you bought the property a few years ago, it’s likely you secured a higher mortgage rate.
Obtaining a lower mortgage rate can help you save money in the long run, but make sure you calculate the numbers. Refinancing comes with fees, so you need to ensure it’s worth it for your personal situation.
Switch to a Variable-Rate or Fixed-Rate Mortgage
Variable-rate mortgages have interest rates that vary with the market throughout the course of the loan, though the initial interest rate is fixed for an agreed-upon period of time. The rate fluctuates after this initial period.
Fixed-rate mortgages stay the same throughout the mortgage term. For example, you can lock in a mortgage rate of say 2.5% for 5 years.
With variable rates, a mortgage holder faces the possibility of a high rate at unexpected times. However, interest rates rise and fall with the market. If you convert from a fixed rate to a variable rate when interest rates are generally low, you could save money on your mortgage interest. However, if interests are rising, it’s more prudent to stick with a fixed-rate mortgage.
Debt consolidation is a popular goal for people refinancing their mortgage. With household debt stats rising to nearly 170% in Canada, mortgage refinancing might seem like a good idea for some and offer relief.
Before considering refinancing your mortgage to pay off debt, be aware of the kinds of debt that you have. If you have bad spending habits and tend to rack on credit card debt, mortgage refinancing won’t break those habits. If anything, refinancing might encourage you to continue making poor financial decisions and risk losing even more equity in your home.
However, if your debt is explained by anything other than poor spending, refinancing your mortgage might be a valid option. Still, you should only use refinancing as a solution to debt if you’re confident that you will certainly spend the extra money to pay your debts.
Lower Monthly Mortgage Payments
If you’re hoping to decrease your monthly mortgage payments, refinance your mortgage. It can help if you secure a longer mortgage loan term length. By adding more time to the length of the loan, you space out your payments more. This decreases the money you spend each month on your principal mortgage payments.
Steps to refinance a mortgage
Explore options from different lenders to get an idea of what’s available to you. Look into mortgage refinancing options from local and larger banks, credit unions, and alternative lenders and compare their offerings. Compare interest rates, term lengths, closing costs and other fees to get an all-encompassing picture.
Don’t fall for online offers
Some online lenders might entice you with low rates that seem too good to be true – that means, they usually are. Remember, online offers aren’t promised agreements, they are just advertisements. Don’t interpret anything as truth until you have it in writing.
Submit a mortgage application to a couple of lenders, within a week or two.
By submitting applications in the same time frame, you minimize the hit on your credit score.
Pick the mortgage with the most favourable terms for your personal situation.
Compare interest rates, fees, and term lengths. Consider using a mortgage calculator.
Lock your interest rate and close on your new mortgage!
Make sure you pay attention to the closing fees and confirm that they are the same as what you agreed to when you signed.
Refinancing your mortgage is a great way to realize equity, consolidate debt, secure lower interest rates, and lower monthly payments. However, with all big financial decisions, it’s important to consider the risks and returns. You will face fees for breaking your mortgage early, and more fees for refinancing. Mortgage refinancing comes with high costs, so make sure you spend enough time calculating the numbers before making a decision. If you’re struggling with debt and are considering options to consolidate, contact a credit counsellor today.