Cash-Out Refinance Canada 2024
What You Should Know
- A cash-out refinance lets you borrow against your home’s equity by refinancing your current mortgage for a larger mortgage amount and cashing out the difference.
- You can borrow up to 80% of your home’s value with a cash-out refinance.
- Cash-out refinances are usually used for debt consolidation, home improvements and renovations, and investments.
- There can be significant penalties for a cash-out refinance that is done before the end of your mortgage term.
What Is a Cash-Out Refinance?
With a cash-out refinance, you refinance your existing mortgage to a new, larger mortgage and ‘cash out’ the difference between the two in the form of a lump sum amount. In other words, a cash-out refinance lets you borrow against your home’s equity through a mortgage refinance. Cash-out refinances are sometimes referred to as equity take-out.
How Much Can You Cash Out With a Cash-Out Refinance?
The maximum LTV (loan-to-value) ratio for a cash-out refinance is 80%, which means you may be able to borrow up to 80% of your home’s value.
Depending on your credit and income, you might not be able to qualify for an 80% LTV. If you have bad credit, the maximum allowed LTV by your lender might be significantly lower.
To calculate how much you can borrow, use our mortgage refinance calculator to see how much home equity you can access and how a change in mortgage rates can affect your mortgage payments.
Example of Cash-Out Refinance
For example, let’s say that your home is valued at $500,000, and you currently have a $300,000 mortgage. This means that your current LTV is 60% ($300,000 ÷ $500,000 x 100). If the lender allows you to borrow up to an LTV of 80%, you can borrow up to an additional 20% of your home’s value, or $100,000. Then, you can refinance your mortgage for $400,000 and withdraw $100,000 in cash. This means your new mortgage balance would be $400,000.
How Does a Cash-Out Refinance Work?
Cash-out refinance works similarly to standard refinance, replacing your existing mortgage with a new one with new mortgage rates and terms. The difference is that cash-out refinance lets you borrow more than the remaining principal of your mortgage, while a standard refinance doesn’t involve borrowing more than what is left of your mortgage.
The amount that you can borrow with a cash-out refinance will depend on how much home equity you have. Over time, as you continue to make mortgage payments, your mortgage balance will decrease, and your home equity will increase if your home value stays the same. The home value also affects your home equity. If the value of your home increases, then your home equity also increases, and if home values decrease, then your home equity will also decrease.
The general steps involved in a cash-out refinance are as follows:
Find a lender to work with: You can shop around for the best refinance rates in the market and find a lender that is willing to work with you. If you have been making your mortgage payments on time and have a good credit score, most lenders will be willing to work with you. If you let your current lender know that you are shopping around, they will likely offer you a good deal. If you have problems such as bad credit, you will have to look for lenders that specialize in bad credit mortgages.
Calculate your home equity: Your home equity is based on the value of your home and the size of your mortgage. Your lender will need your home’s value to be appraised, as they will only consider this value as the value of your home. The difference between your home’s value and any debt tied to your home, such as your mortgage, is the equity that you have in the home.
Decide how much to borrow: Once you know how much equity you have in the home, you will know how much you can borrow. Most lenders will allow you to borrow up to 80% of the home’s value when you have a good credit score. However, your exact borrowing limit would also depend on your debt service ratio. Based on the equity you have, the maximum amount you can borrow, and the purpose of borrowing, you can decide how much to borrow.
Refinance: Once you are set on a lender and a cash-out amount, you can go ahead with the refinance. This means you get a new mortgage and pay off your old mortgage. You should note that you will likely have to pay penalties for paying off your old mortgage if you are not refinancing at the end of your term.
Cash-Out Refinance vs Refinance
The difference between a cash-out refinance and a refinance is the amount that you are borrowing. With a regular refinance, your new mortgage will be for the same amount as your existing mortgage, while your mortgage rate, your amortization period, or both may change. If your new mortgage rate is lower, you will save money through lower mortgage interest payments. With a cash-out refinance, you are increasing your mortgage balance amount, in addition to other possible changes. Since you are borrowing more money, your mortgage payments might also be larger.
Pros and Cons of Cash-Out Refinance
Pros of a Cash-Out Refinance
With a cash-out refinance, you can typically borrow a large amount of money at a low-interest rate, and it will require lower monthly payments than other borrowing methods. Here are the pros of a cash-out refinance:
- Borrow More Money
The main purpose of cash-out refinancing is to borrow more money. However, cash-out refinances are chosen so borrowers can borrow a large amount of money all at once. In comparison, other options, such as personal loans or lines of credit, have a lower borrowing limit.
- Borrow at a Lower Cost
The interest rate for a cash-out refinance will typically be lower compared to personal loans, credit cards and HELOCs; therefore, the cost of borrowing may be significantly lower.
- Lower Your Interest Rate
If the ongoing refinance rates are lower than your current mortgage interest rate, you could save on interest costs by refinancing at a lower rate while also being able to access the equity.
- Borrow With Smaller Required Payments
Mortgages are amortized over a period that can be 25 years, and sometimes even longer, meaning the payments are spread out over a very long period of time. If you were to get a personal loan instead, you would have to repay the loan in a shorter period of time, which would require higher loan payments.
- Improve Credit
If you use the cashed-out amount to pay off other debts, you may be able to reduce your credit utilization, which can positively impact your credit score.
Cons of a Cash-Out Refinance
The pros are all based on borrowing more money, but borrowing more can be a con. Borrowing more means that you will be paying more. Here are the cons of a cash-out refinance:
- Increased Mortgage Balance
When you cash out some equity, the amount is added back to the mortgage balance. This means your monthly payments would increase, or you would have to extend your amortization period. Thus, you will either have to make more payments each month or keep paying for longer than the original mortgage.
- Interest Rate May Increase
The cash-out refinance rate is often higher than refinance mortgage interest rate. In such a case, you will pay more interest than you otherwise would.
- Higher Risk
Borrowing more money with your home as collateral means that you are putting your home more at risk than before if you cannot keep up with mortgage payments. This is especially true since your cash-out mortgage payments will now be higher. If you can’t keep up with your payments, you might face foreclosure or power of sale.
What Should a Cash-Out Refinance Be Used For?
Since you still need to pay interest on the additional amount that you borrow, you should use the money wisely. This can include things that can save you money or can make you more money. Some uses for a cash-out refinance include:
Paying Off Other Debt
Consolidating your debt can save you lots of money, especially if it’s high-interest debt such as credit cards. You can pay off credit cards, personal loans, lines of credit, car loans, and student loans with money from a refinance.
Home Improvements and Renovations
Home renovations can help increase the value of your home, which means that you are putting your home equity to work to generate even more home equity. Home renovation projects can include a kitchen remodel, upgrading your landscaping, replacing your appliances, or even making energy-efficient improvements that can reduce your heating and water bills. If you have a CMHC-insured mortgage, making energy efficiency upgrades can even save you money through CMHC insurance premium refunds.
Investments
You can use money from your mortgage refinance to invest. This might be starting a new business investing your money in stocks, or even purchasing another property based on the BRRRR method. Borrowing money to invest can be risky, especially if your returns aren’t guaranteed. That’s because you’re still paying interest no matter your return, and if you have negative returns, then you will need to find a way to pay the losses back eventually.
A 2019 study by the Bank of Canada tracked the spending of the money borrowed from home equity, including that from HELOCs and cash-out refinance, with the following results:
Use of Home Equity Dollars
| Debt Consolidation | 28% |
| Home Renovations | 25% |
| Consumption | 25% |
| Investments | 22% |
Alternatives to Cash-Out Refinance
Cash-out refinance isn’t the only way to access your home equity. Refinancing your home can come with large mortgage penalties if you refinance before the end of your term. You will also be forced to accept the market’s current mortgage rates, which might not be ideal if you’re already locked into a lower rate. The alternatives to cash-out refinancing you could consider are as follows:
Home Equity Line of Credit (HELOC)
A home equity line of credit lets you access your home equity just like a credit card. In Canada, the maximum borrowing limit for HELOCs is 65% of your home’s value. HELOC is a much more flexible alternative to a mortgage refinance because you don’t have to borrow a lump sum at once and pay interest on it even if you don’t need the entire amount at once. However, HELOC rates are typically higher than refinancing rates. HELOC rates are usually variable interest rate based on the prime rate.
Home Equity Loan
A home equity loan is a second mortgage secured by your home that you can get in addition to your existing mortgage. Taking a home equity loan won’t affect your mortgage, meaning you won’t need to pay any mortgage penalties since your existing mortgage stays the same. Home equity loans tend to have higher interest rates than mortgage refinance.
Reverse Mortgage
A reverse mortgage is a unique mortgage that lets Canadians over 55 years of age access their home equity through lump-sum payments or through regularly scheduled payments. This sets up a steady stream of income that can be useful for retirees or those needing to supplement their income.
FAQ
Money from a refinance is still borrowed and will eventually need to be paid back. That’s why it is better to direct it towards productive uses, such as saving or making money. Refinancing can also be used to pay for things that you really need, like using it to buy a new car. Things that a refinance might not be a good idea for are non-essential consumption and spending, such as vacations or jewelry. If you couldn’t otherwise afford it without a refinance, spending a cash-out refinance on it might not be a good idea.
You can still refinance your mortgage even if you have bad credit. However, you may be approved for a smaller amount than you would like, and your interest rate might be higher. Since you are replacing your old mortgage with a new mortgage, you will need to pass your lender’s minimum credit score requirements for a mortgage. You will also need to pass the mortgage stress test when refinancing your mortgage.
Having a bad credit score can make it difficult to be approved for a cash-out refinance with a traditional bank. A monoline lender or private mortgage lender may approve you for a refinance, but you might be charged significant fees and interest rates because of having a bad credit score. If you know that you want to refinance your mortgage in the future, then you should try to improve your credit as soon as possible.
The simple answer is no. Your cash-out refinance money is debt, not income, since you will eventually have to pay it back. You won’t need to report your refinance cash out as income when filing your income taxes.
In Canada, your mortgage interest isn’t tax deductible, even for cash-out refinances. That’s because you can only deduct interest at tax time if the loan was used for investments. One way around this is called the Smith Maneuver, which is a way for you to turn your mortgage interest into a tax-deductible expense.