Many Canadians wonder what it means to refinance a mortgage. Alex Lavender – Mortgage Broker will tell you exactly what a mortgage refinance means, the penalties involved, and the pros and cons.
What is a mortgage refinance?
A refinance is when you obtain a new mortgage for a higher amount to pay off your existing mortgage. If you are looking to keep your mortgage amount the same but just move to a new lender at a better rate then that transaction would be called a switch / transfer.
Refinancing your mortgage can be a great solution to pay down high interest debt, upgrade/renovate your home, or obtain funds to purchase another property. When you do a refinance you may have the ability to obtain a lower rate than you currently have. You also have the ability to extend your amortization to as far as 30 years, which could offset the increase in the mortgage amount and keep your payments the same.
3 key points to consider when refinancing:
Mortgage Amount
The highest mortgage amount you can obtain is 80% of the value of your home. Initially you will use an estimate to value how much your home is worth, compared to other properties that have sold in your neighborhood. When the file is approved by the lender they will either request an appraisal to determine the value or they will pass it through the automated valuation system to see if the value is automatically supported.
If your current mortgage exceeds 80% of the value, then a refinance is not possible. For example, if your home is worth $300k the most you can refinance up to is $240k (80% of $300k). If your existing mortgage is $260k then a refinance would not be possible. If your existing mortgage was $200k then you could obtain up to $40k on the new mortgage.
Penalties
The most important thing to review when considering a refinance is to find how much your penalty may be with your existing lender. If your mortgage is up for renewal within the next 120 days then the new mortgage can be aligned with the maturity date so there is no penalty. However if you are not near the maturity date you may incur some significant penalties.
The penalties for a fixed rate mortgage are the highest with the big 5 banks and could be equal to around 4% of your mortgage amount as the penalty. This is why I always advise clients to use a monoline lender when they are considering a fixed rate mortgage as the penalty tends to be around 0.50% of the mortgage amount instead. If you have a variable rate mortgage then the penalty will be significantly less. With almost every lender the penalty for a variable rate mortgage is equal to 3 months of interest, which roughly calculates out to be around 1.5 monthly mortgage payments.
Also if you received cash back or any other incentives with your mortgage then it could increase your penalty even further, some lenders will require the full cash back amount to be paid back if you break your mortgage even one day early. It is always a good idea to make a quick call and just confirm what the penalty is if you pay out your mortgage early.
Transaction costs
There are a few costs when completing a refinance transaction. If you are moving to a new lender with a refinance then your existing lender will likely charge a discharge fee, which is usually around $300. If your property does not pass through the automated valuation system then an appraisal will be required, and this is usually between $350-$750 depending on the appraiser. There are also legal costs involved with the transaction.
A title insurance company or a lawyer will complete the legal work to process the new mortgage, the costs for this typically range between $600-$1,500 depending on the complexity of the transaction. The only cost that you would need to pay up front is the appraisal if it is required, all of the other costs can be paid from the refinance proceeds. Some lenders do offer promotions at times where they may cover some or all of these costs as well.
Mortgage Refinancing Summary:
If the benefits outweigh the costs then a refinance can be a great option. If you are able to obtain a lower interest rate than you are paying now or consolidate a significant amount of high interest consumer debt then the savings can be significantly higher than the costs. If it is something you are considering, feel free to reach out, I would be more than happy to help.