What Is Mortgage Refinancing?
Mortgage refinancing in Canada means paying off your existing mortgage and replacing it with a new one, typically with different terms. The new mortgage can be with the same lender or a different one, and it may have a different interest rate, amortization period, or loan amount.
When you refinance, you are essentially renegotiating your mortgage contract. This allows you to access the equity you have built in your home, either to get a lower interest rate, consolidate debt, or fund a major expense. However, refinancing is not the same as renewing your mortgage, which simply continues your existing loan at the end of its term without necessarily changing the terms.
Sources: Ratehub.ca, TD Canada Trust
Reasons to Refinance: Lower Rates, Debt Consolidation, and Home Equity
Homeowners refinance for several common reasons, and understanding these can help you decide if refinancing is right for your situation. The main motivations are:
Securing a lower interest rate: If current mortgage rates are lower than your existing rate, refinancing could reduce your monthly payments or shorten your amortization.
Accessing home equity: Refinancing can provide a lump sum of cash by increasing your mortgage amount, up to 80% of your home's appraised value minus your outstanding balance. This equity can be used for renovations, investments, or other large expenses.
Consolidating high-interest debt: By rolling credit card balances, car loans, or other debts into your mortgage, you can often lower your overall interest costs. This is a popular debt consolidation strategy, but it spreads the debt over a longer period, so you need to be careful about total interest costs.
Changing mortgage features: You might want to switch from a variable to a fixed rate, or vice versa, or adjust your amortization period to better fit your financial goals.
Sources: Ratehub.ca, TD Canada Trust
How Refinancing Works in Canada: The Process
Refinancing involves several steps, and it's important to understand the sequence to avoid surprises. The process typically includes:
1. Determine how much equity you have. Your home's appraised value minus your current mortgage balance gives you your equity. Generally, you can refinance up to 80% of the appraised value, minus what you owe.
2. Check your financial profile. Lenders will review your income, employment, credit score, and debt service ratios. You will need to pass the mortgage stress test, which means you must prove you can still afford payments if interest rates rise.
3. Shop around for rates and terms. Compare offers from your current lender and other lenders, including banks, credit unions, and alternative lenders. Be aware that fees and penalties can vary.
4. Apply for the new mortgage. You'll need to provide documentation, and the lender will order an appraisal of your home. The lender will also do a hard credit inquiry, which can temporarily lower your credit score.
5. Pay off the old mortgage and close the new one. On the closing date, the new lender pays off your existing mortgage, and you start making payments under the new terms. You'll also pay any applicable legal fees, appraisal fees, and registration fees.
Sources: Ratehub.ca
Costs and Penalties to Consider
Refinancing is not free. There are several costs and penalties that can add up, and you need to factor them into your decision:
Prepayment penalty: If you refinance before the end of your mortgage term, you will likely have to pay a prepayment penalty. For variable-rate mortgages, this is typically three months' interest. For fixed-rate mortgages, it is generally the greater of three months' interest or the interest rate differential (IRD). The IRD is the difference between your current rate and the current rate for a similar term, multiplied by the remaining balance and time left in your term. In some cases, this can amount to thousands of dollars.
Other costs: You may also need to pay for a home appraisal, legal fees, a discharge fee to release your old mortgage, and registration fees for the new mortgage. These costs vary by lender and location.
It's wise to calculate the total cost of refinancing and compare it with the potential savings. If you are refinancing to get a lower rate, the savings need to outweigh the costs over the time you plan to stay in the home.
Sources: Ratehub.ca
Refinancing vs Home Equity Line of Credit (HELOC)
When you want to access your home equity, you have options beyond a traditional refinance. A Home Equity Line of Credit (HELOC) is a popular alternative. Here's how they compare:
A refinance gives you a lump sum of cash, which you repay over the mortgage term. You can usually borrow up to 80% of your home's value, but you will incur a prepayment penalty if you break your existing mortgage term.
The choice between a refinance and a HELOC depends on your needs. If you need a specific amount for a one-time expense, a refinance may be appropriate. If you want ongoing access to funds, a HELOC offers more flexibility.
Note: Some homeowners use a combination of both, such as a mortgage with a HELOC component, but that product is not covered in this guide.
- Refinance: Lump sum payment, max LTV often 80%, prepayment penalty may apply when breaking term.
| Aspect | Refinance | HELOC |
|---|---|---|
| Lump sum vs credit line | Lump sum | Revolving credit line |
| Prepayment penalty | May incur penalty if breaking term (3 months interest or IRD) | No prepayment penalty typically |
Sources: Ratehub.ca
How the Stress Test Affects Refinancing
The Canadian mortgage stress test is a key factor in refinancing. It is designed to ensure you can still afford your mortgage payments if interest rates rise above your contract rate. Lenders apply it when you refinance, just as they do when you first get a mortgage.
The stress test uses two debt service ratios: the Gross Debt Service (GDS) ratio and the Total Debt Service (TDS) ratio. The GDS ratio is typically limited to 39% of your gross household income, and the TDS ratio is typically limited to 44%. These percentages are general guidelines and can vary by lender and your specific financial situation.
What this means for you: When you refinance, the lender will calculate your payments at the stress test rate, which is often higher than the actual contract rate. You must qualify based on that higher payment amount. If your income or debts have changed since you got your original mortgage, you may not qualify for as much as you hoped.
It's important to check with your lender or a mortgage professional to understand how the stress test will apply to your refinance.
Sources: Ratehub.ca, Scotiabank
Frequently asked questions
Can I refinance my mortgage with the same lender?
Yes, you can refinance with the same lender. In fact, this can sometimes reduce costs because the lender already has your file and may waive some fees, but you should still compare offers from other lenders to ensure you get the best rate and terms. Note that if you have a collateral charge mortgage, switching lenders may involve fees to remove the charge and register a new one.
Sources: Government of Canada, Ratehub.caHow much equity do I need to refinance?
Generally, you need enough equity to bring your loan-to-value (LTV) ratio to 80% or less. That means your existing mortgage balance must be less than 80% of your home's appraised value. Lenders will require an appraisal to confirm the value.
Sources: Ratehub.caRepair credit before refinancing?
Lenders review your credit score as part of the refinancing application. A higher credit score generally improves your chances of approval and helps you secure a better interest rate. If your credit score is low, it may be wise to work on improving it before you refinance, but it's not a strict requirement. You can still refinance with a lower score, though you may face higher rates.
Sources: Ratehub.caWhat is the maximum loan-to-value for a refinance?
The maximum loan-to-value (LTV) for a refinance is typically 80% of your home's appraised value. This means you can borrow up to 80% of the value, minus your existing mortgage balance. This limit is a general guideline, and individual lenders may have their own policies.
Sources: Ratehub.ca, TD Canada TrustShould I refinance to buy a second property?
Refinancing can be used to access home equity for a down payment on a second property. You would receive a lump sum from your refinance, which you could then use for the purchase. However, you must consider the costs and penalties of refinancing, and whether your income can support the additional debt. There is no specific rule against this use, but lenders will assess your overall debt ratios and the stress test to ensure you can handle the new mortgage.
Sources: Ratehub.caSources
- Renewing your mortgage — Government of Canada
- Mortgage Refinance in Canada | Reasons, Methods and Costs | Ratehub.ca — Ratehub.ca
- Mortgage Refinance Calculator | Ratehub.ca — Ratehub.ca
- Mortgage Refinance - TD Canada Trust — TD Canada Trust
- What is the Canadian mortgage stress test? | Posts — Scotiabank