Many Canadians have financial issues, even at the best of times. Throw a record-breaking inflation into the mix and finances can get even more stressful.
Over half of Canadians say they’re worse off financially than a year ago, and a third of them believe things will get worse in the coming year. Many people who are struggling financially often consider taking out a loan to help ease their cash flow worries.
A popular choice among homeowners is to refinance a mortgage, which can often be a better option than a personal loan or line of credit. But what does it mean to refinance a mortgage? And is it the right choice for you?
To help you decide, we take a look at the refinance mortgage meaning, the credit score needed to refinance a mortgage and lender refinance rates. We also examine the difference between a mortgage renewal vs. refinance, mortgage refinance closing costs, if you can refinance a mortgage with bad credit and when not to refinance a mortgage. We also explore a refinance mortgage alternative option for Canadian homeowners age 55-plus.
What is a refinance mortgage?
A refinance mortgage (or mortgage refinance) is when you change the terms of your current mortgage, usually to increase the amount of money you owe. The refinance mortgage meaning, therefore, is to make a significant change to your current mortgage, often by changing the lender and/or the principal amount.
How does a mortgage refinance work?
In Canada, in theory, you can get a mortgage refinance for up to 80% of the value of your home, minus what you already owe. So, let’s say you own a home worth $600,000 and your current mortgage is $200,000. You could refinance your mortgage for an extra $280,000. Here’s how it’s calculated:
80% of $600,000 = $480,000
$480,000 – $200,000 = $280,000
In this instance, you may be tempted to wonder, should I refinance my mortgage for $280,000? Probably not, for a couple of reasons.
Firstly, this level of mortgage refinance would increase your regular mortgage payments by more than double, and put a lot of stress on your cash flow. Secondly, you might not qualify for this amount of money. While 80% of your home’s value is the maximum you could borrow up to, you also need to qualify according to your lender’s debt service ratios.
There are mathematical formulas that take into account your income, your debts, your expenses and your new mortgage payments, to work out if you can afford to pay your mortgage. If your income is too low, and/or your debts, expenses and mortgage payments too high, you won’t qualify for this level of mortgage refinance.
When you refinance a mortgage, you are basically taking on a brand-new mortgage, so it’s an opportunity to change several aspects of your old mortgage, such as:
- Having a different interest rate
- Borrowing more (or less) money
- Changing the amortization (the number of years it will take to pay off the loan in full)
- Changing the mortgage term (the number of years you sign up to this particular mortgage contract)
- Changing the mortgage payment regularity (such as monthly or bi-weekly)
Why should I refinance my mortgage?
Homeowners typically refinance their mortgage to cash in a lump sum from the equity in their home. There can be a wide range of reasons why someone might want to access a large amount of money:
- Pay off high-interest debt (such as large credit card balances).
- Consolidate all of their debts into one cheaper and more manageable debt.
- Pay for renovations.
- Cover unexpected costs (such as a new roof or furnace).
- Make investments.
- Install a new bathroom or kitchen.
Should I refinance my mortgage if I have a lot of high-interest debt? This is certainly the reason why a lot of people refinance their mortgages. If you owe thousands on high-interest credit cards, shifting that debt to one with interest that is as low as a quarter of what you were paying could save you thousands of dollars in interest over a five-year period.
It can also help with your cash flow. Transferring high monthly debt payments into one much lower monthly debt payment can free up a lot of your income.
It can reduce your stress and get your finances back to a more manageable and sustainable level. It could also help improve your credit score.
There is a cost to refinance a mortgage (which we’ll cover in more detail), so you need to be sure that it’s the best financing option available to you. Also, when you compare a mortgage renewal vs. refinance, rates are usually higher when you refinance a mortgage. So, you need to ask yourself: is the extra cost to refinance a mortgage worth it?
Pros and cons of refinancing a mortgage
While increasing the amount of money you owe on your home requires some serious thought, a mortgage refinance certainly has some key potential advantages:
- Mortgage refinance rates are among the lowest interest rates available, when compared with other options.
- Potentially save thousands of dollars by consolidating debt.
- Reduce your financial stress.
- Lower your monthly outgoings to a more manageable level.
- Change the terms of your mortgage contract.
- Pay for large expenses, such as a home renovation or emergency repair.
- Use the money to invest.
What is a refinance mortgage’s main disadvantage? Mortgage refinance rates are typically a little higher than a straight renewal mortgage rate (when you renew your mortgage contract without changing the amount of money you owe). Plus, you’ll pay this mortgage refinance rate on the whole amount, not just the extra that you took out of your equity.
Also, there is a cost to refinance a mortgage, even if you do it when your contract is up for renewal. And if you refinance your mortgage during your contract period, you’ll probably have to pay a prepayment penalty, which can be thousands of dollars.
The cost to refinance a mortgage
Even if you don’t have to pay a prepayment penalty, there are still costs to refinance a mortgage. Mortgage refinance closing costs include:
- Mortgage discharge fee (if you’re switching lenders).
- Mortgage registration fee (a refinance is effectively a new mortgage, so it has to be registered against your home).
- Legal fees (required by law for a refinance).
- Appraisal costs (if your new lender needs your property to be valued).
If you’re switching lenders, however, your new lender may cover these costs or at least some of them.
Mortgage refinance FAQs
Can you refinance a mortgage with bad credit?
While the credit score needed to refinance a mortgage varies from lender to lender, most banks and credit unions usually want to see a credit score above 660.
If you have a score below that, you might struggle to get a refinance mortgage with many conventional financial institutions. However, there are “B” lenders and private lenders who might refinance your mortgage, but their rates will be considerably higher than the banks’ rates.
What does it mean to refinance a mortgage mid-term?
This is when you break your current mortgage to take out some equity (by increasing the principal on your loan) and/or change the interest rate (usually to a better one). Many people consider this an example of when not to refinance a mortgage, because the penalties for breaking a mortgage can be in the thousands.
What’s the difference between a mortgage renewal vs. refinance?
A mortgage renewal is for the exact same amount of money and often with the same lender. A mortgage refinance usually involves an increase in the loan amount, and a change in interest rate and/or lender.
Should I refinance my mortgage to pay for renovations?
A mortgage refinance can often be a good choice for renovations, if you’re happy with spreading repayments over the life of your mortgage. If you want to pay the loan off faster, a line of credit or personal loan might be a better option.
What is a refinance mortgage’s main advantage?
It enables you to cash in up to 80% of the equity in your home while paying a mortgage interest rate on the loan, which is typically considerably lower than the interest on a personal loan or line of credit.
Mortgage renewal vs. refinance vs. reverse mortgage
For homeowners aged 55-plus, there is an alternative to both a mortgage refinance and a renewal. Retired homeowners with a conventional mortgage can often find that mortgage payments make a huge dent in their retirement income.
Instead, you could take out a reverse mortgage and use it to pay off your current conventional mortgage. The key advantage would be that you’d no longer have to make regular monthly mortgage payments (you only pay back what you owe when you sell your home or move out). This would free up a lot of your retirement income and help you to have a more enjoyable retirement.
If you also need extra money to pay for renovations or another large expense, you could qualify for a reverse mortgage that can pay off your conventional mortgage and provide an extra lump sum.
A reverse mortgage can also be easier to qualify for compared to a conventional mortgage, because your credit score and income are not qualifying factors. Call us today at 1-866-758-2447 to find out how much you could borrow with a CHIP Reverse Mortgage, instead of taking out a mortgage refinance.