Mortgage Refinancing: How Does It Work & What Are the Benefits?
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A Look at Mortgage Refinancing & How It Can Benefit Homeowners
Refinancing, in its simplest definition, is when you take out a new mortgage to replace your current one, either for the same amount or slightly more money.
But what is the purpose of refinancing?
In some cases, refinancing can save you money and offer you more financial freedom. However, there are other benefits as well.
To see if a remortgage is right for you, here’s a look at what refinancing is, how it works, and why homeowners can benefit.
Refinancing Explained
Refinancing—also referred to as a remortgage—is when you transfer your mortgage to a new lender mid-term in order to increase the loan amount or amortization. Refinancing is also used to negotiate better mortgage rates and terms.
Often, homeowners choose refinance with a different lender that has a more favourable interest rate. They may also remortgage to reduce their monthly payments, pay off their mortgage faster, raise capital, or consolidate more expensive high-interest debts.
How It Works
When you remortgage your home with a new lender, the terms or amount of your mortgage will change, and the new lender will delete the current mortgage lien registration and draft a new legal registration with a new mortgage amount and amortization.
You can choose to remortgage at any time, but you will save more money if you do so at the end of your current mortgage term, as you most likely will have to pay a penalty for re-financing early. However, also keep in mind that there is an exception to this, as many lenders often include up to $3,000 of the mortgage penalty in your new mortgage.
The amount of this prepayment penalty will depend on several factors, such as your lender’s prepayment policies, the number of years left on your current mortgage’s term, and whether you have a fixed or variable-rate mortgage. This can also depend on your type of lender. For instance, the big banks typically have larger penalties, while smaller mortgage companies will offer lower penalties.
At the end of your mortgage term—or contract—you are free to remortgage with new lenders without penalty. However, there are often legal fees associated with refinancing, but some lenders will consider paying for these costs.
So, be sure to find out what your current lender’s prepayment penalty is before breaking your current mortgage and whether your new lender is willing to cover the legal fees and roll any prepayment penalty into your new mortgage.
Consider Your Credit Score
If your credit score has increased since you applied for your existing mortgage, you may qualify for lower interest rates when remortgaging depending on the current rates available. But borrowers with poor credit might find that paying for a remortgage isn’t worth the extra effort and money.
Typically, having a low credit score will limit the mortgage products available to you, and you may end up facing a loan rejection or only qualifying for products with high interest rates.
Why Remortgage?
While typically, the main goal is to improve your financial situation, mortgage refinancing can have other benefits as well.
Here are the top reasons most people consider mortgage refinancing.
Your Current Deal Is Ending
If your mortgage term is coming to an end, your lender will likely offer you a mortgage renewal rate which is slightly higher than the current best market rate. That is because most borrowers simply sign the renewal and take what they are offered by the existing lender. This is a good time to speak with a Mortgage Broker to find out if there are better rates available.
Better Interest Rate
Switching to a mortgage with a lower interest rate can provide huge savings compared to your current mortgage. A lower interest rate means lower monthly payments to free up more income. And you can pay down more of the principal on your mortgage faster.
Flexibility
Refinancing is an excellent option for those who want a more flexible mortgage—for example, a mortgage that allows you to take payment holidays or make overpayments when you come into extra money.
Cash in On Some Equity
With a remortgage, you can borrow up to 80% of your home equity—the value of your home. Homeowners often tap into their home equity to pay off high-interest debt, pay for renovations, buy investments such as a second property, or help family members with large purchases such as weddings or tuition for post-secondary education.
Some retirees may also refinance their homes to increase their retirement income.
Consolidate Debt
Refinancing a mortgage is a good option to consolidate high-interest debt. By borrowing more on your mortgage with a low interest rate, you can pay off high-interest debt and save hundreds, if not thousands, of dollars in interest over the years.
Home’s Value Has Increased
If your home’s property value has increased significantly since you took out your current mortgage, you may be in a lower loan-to-value bracket and qualify for much lower interest rates.
Worried About Interest Rates Increasing
Locking in lower interest rates before they go up is a common reason for remortgaging. Also, when interest rates go up, those with variable-rate mortgages will see an increase in their mortgage payments.
So, if you have a variable-rate mortgage and you’re concerned that interest rates are on the rise, then switching to a fixed mortgage might give you peace of mind.
You Want to Borrow More
Homeowners who wish to borrow more money for home renovations or debt consolidation may not be able to with their current lenders, or their current lenders offer terms that aren’t ideal. So, refinancing with a new lender may be the best option to borrow more money.
You Want to Overpay (Pay Your Mortgage Faster)
Some lenders won’t allow borrowers to overpay—make larger payments—to pay down their mortgage faster. But if your income has increased or you’ve come into some extra money, and you want to pay off your mortgage faster, a remortgage might be your best option. With a remortgage, you can reduce your loan size and at a lower interest rate.
Benefits of Remortgaging
With a remortgage, you can benefit from the following:
- Save money with a lower interest rate
- Save money by consolidating expensive high-interest debt into much cheaper debt
- Be mortgage-free faster if you remortgage with better prepayment privileges or a shorter amortization period
- Switch to a mortgage that is more suitable to your financial situation
- Tap into home equity as a cheaper alternative to high-interest loans for large purchases and investments
Drawbacks of a Remortgage
Here are some of the costs that might arise when remortgaging:
- If you are remortgaging to borrow a larger amount of money, you mighthave larger monthly mortgage payments, which will decrease your disposable monthly income. And if you increase your amortization period to avoid higher monthly payments, you will end up paying more in interest overall.
- There are costs associated with remortgaging, such as an exit fee and an early repayment charge—which can be as low as three months of interest and as high as 5% of your current outstanding loan. So, you will need to weigh the costs of remortgaging with the benefits—i.e. will you end up saving more money than you will spend to switch lenders?
- The same costs you had to pay when applying for your first mortgage may also be applied when you remortgage—such as administrative fees, property valuation fees, and legal fees.
- When your home is used as collateral, you risk losing your home if you can’t keep up with your monthly mortgage payments.
- Lastly, when applying for a remortgage,you will have to pass the mortgage stress test. So, if your income isn’t high enough to cover your monthly expenses, then you may not pass this test.
Though there are extra costs associated with refinancing, a remortgage can help you save plenty of money, be mortgage-free faster, and free up some cash to put toward important things in life. So be sure to weigh the costs and benefits of remortgaging, and speak with your mortgage broker to see if refinancing is right for you.
Chris Allard’s experience in the field means he can get you offers with over 50 financial institutions lending in Ottawa. Every lender has many mortgage products they offer, which means Chris and his team will make sure a mortgage caters to your needs while also ensuring you get a competitive rate. Chris Allard is a proud mortgage broker of Smart Debt Mortgages, independently owned and operated. Smart Debt broker #12236.