Five things to consider when refinancing your mortgage
Nov 4th, 2021 | By FCT
Mortgage refinancing offers many Canadians a powerful tool to consolidate debt, get a better interest rate or even fund large projects and investments. There are great reasons to consider refinancing, but it’s not for every homeowner. Before moving forward, consider these five factors:
1. Your credit score and debt servicing ratios
To get the best interest rates and put less than 20% down, you need to qualify for Canadian Mortgage and Housing Corporation (CMHC) insurance in two key areas: your credit score, which needs to be at least 600, and your debt servicing ratios. These take two forms:
- The Gross Debt Service (GDS) ratio measures what percentage of your income before taxes would have to go toward monthly housing costs: mortgage, property taxes, heating bill and condo fees, if applicable. To qualify, it can’t be higher than 39%.
- The Total Debt Service (TDS) ratio measures the percentage of your income before taxes needed to cover all debt payments. It includes GDS as well as any other debt payments, like student loans, car payments and any lines of credit. To qualify, it can’t be higher than 44%.
Use the CMHC debt service calculator to help determine your GDS and TDS ratios.
2. Your current equity
Your home equity refers to how much of your home’s value you own. When you refinance, you can borrow up to 80% of your home’s current value minus how much you still owe on your current mortgage.
- Example: your home is appraised at $800,000 as part of securing the refinance deal, and you still owe $200,000 on the mortgage. Your maximum loan would be 80% of the $600,000 remainder, or $480,000.
Your debt servicing ratios play a role here as well, impacting how close to that 80% a lender will be willing to offer. Too high a ratio and the lender may consider you a risk, less likely to be able to make payments on a large loan.
3. The cost of refinancing
Refinancing involves a few associated costs, so it’s important to calculate whether you stand to gain more from the deal than you’ll spend.
Penalties: If you’re breaking your mortgage before the end of its term, your lender may charge a penalty. Penalties are typically three months’ worth of interest for variable rate mortgages, or the interest rate differential for a fixed rate mortgage—some lenders will use the higher of the two. It’s important to factor in how early you’re breaking your mortgage contract, the difference in the interest rate and how much is still left on your mortgage. Always find out in advance from your current lender if a penalty will apply, and if so, what it will be.
Home appraisal: Your lender will need an up-to-date valuation of your property to determine your home equity and available refinance amount. Some lenders now use automated valuations, but some still send a home appraiser to determine the property’s value.
Closing costs: These can include administrative fees, appraisal fees, reinvestment fees, and a discharge fee. This covers the service itself, as well as the due diligence needed to fund the new mortgage and register it on the title of your property. The cost will vary depending on how early you’re breaking your existing mortgage contract as well as your specific lender, but expect a couple thousand dollars in total closing costs.
4. The current interest rate
One of the most common reasons Canadians refinance is to take advantage of lower interest rates. Taking the above $480,000 example, even a 1% difference can save hundreds of dollars a month. The long-term savings with the new rate may be worth the upfront cost of refinancing.
With interest rates at a historic low, many homeowners are opting to refinance now so they can lock in their rates before they rise again.
5. The right mortgage for you
When you refinance, you have the chance to select a whole new mortgage. You aren’t tied to your same lender or even the same type of loan you had previously. The best thing you can do is to consider all your options.
If you want to pay off your home quicker, now may be a good time to switch from a 25-year mortgage to a 15-year option. Or you can decide you no longer want a variable rate mortgage. You may prefer to go with a fixed rate to ensure that your payments won’t rise during the term of your mortgage.
Make sure you consult a lending professional you trust. The lowest rate isn’t always the cheapest mortgage in the long run, and refinancing every three to five years isn’t always the best option. But done correctly, it can save you a great deal of money or even fund investments or education. You work hard to build your equity—make it work for you.