Refinancing your mortgage means that you will be changing your existing mortgage, such as by switching to another mortgage interest rate or altering the amount of your mortgage. A mortgage refinance is usually done to lock-in a lower mortgage rate, increase the amount of your mortgage to borrow home equity, or both. However, a mortgage refinance before your mortgage term is over will come with a mortgage break penalty.
You should refinance your mortgage if you are able to refinance at a lower mortgage rate that covers the cost of any mortgage penalties for breaking your term early. You can also refinance if you are looking to borrow from your home equity. However, your savings should exceed the penalties for breaking the mortgage.
For fixed-rate mortgages, most major banks charge a mortgage break penalty that is either three months’ worth of interest or something called an interest rate differential (IRD). IRD is the difference between interest on your current non-discounted mortgage rate and the interest on a mortgage for the same time period remaining on your mortgage term at the current posted rate. You can use a mortgage refinance calculator to calculate how much you can save or pay if you decide to refinance your mortgage.
Let’s say that you have a $500,000 fixed-rate mortgage at 3.00% for a five year term, and you have two years remaining. You notice that mortgage refinance rates are currently as low as 2.00%.
If you choose not to refinance, you will pay $29,029 in interest at 3% for the next two years. If you do refinance, you will pay a total of $19,320 in interest at 2% for the next two years. This results in $9,709 in interest savings.
However, breaking your mortgage early will come with prepayment penalties. If the current posted-rate for a 2 year fixed-rate mortgage is 2.5%, then the mortgage penalty, or the cost to refinance the mortgage, will be $5,000. This means that refinancing your mortgage will result in $4,709 in savings over two years.
You can also refinance your mortgage to borrow money if you have enough equity in your home. As you pay off your mortgage, you build up equity in your home. This is the difference between the value of the home and the remaining balance of your mortgage. Your home equity will go up as you pay down your mortgage, and it will also go up if the value of your home increases.
In Canada, you can refinance to borrow up to 80% of the value of your home. If your current mortgage is only 50% of your home’s value, then you can refinance to borrow the remaining 30%.
For example, let’s look at a $400,000 mortgage on a $800,000 home. Your current loan-to-value ratio (LTV) is 50% ($400,000/$800,000). Since you can borrow up to 80%, you still have 30% left over. This means that you can refinance to borrow an additional $240,000 ($800,000 x 0.30).
You can use this money to pay off high-interest debt, such as credit cards, or use it to pay for renovations or for home improvement projects.
A mortgage renewal is done at the end of your mortgage term, with the most popular term being five years. Most homeowners will not be able to pay off the full amount of the mortgage at the end of their term, which means that they will either need to renew, refinance, or switch.
A mortgage renewal is when you keep the same terms as your original mortgage, and at the same mortgage lender. Although your mortgage rate can change, you will not be able to increase the amount of your mortgage to borrow more money.
A mortgage refinance can be done at any time, not just at the end of your term. You can take out money to be used for things such as debt consolidation. While you will be charged penalties for refinancing before your term is up, you can still refinance at the end of your term. Waiting until your term ends will allow you to refinance your mortgage without any additional penalties.
A Home Equity Line of Credit (HELOC) is similar to a mortgage refinance in the sense that you can borrow your home equity, however, there are major differences between these two products.
A HELOC is a revolving account which allows you to borrow money at any time. On the other hand, a mortgage refinance would be a one-time event where you receive a lump-sum amount.
HELOCs also have different credit limits, where you can only borrow up to 65% of the home’s value if you have no mortgage, or up to 80% when combined with a mortgage.
HELOC rates are variable, while refinance mortgage rates can be either fixed or variable. If you choose a fixed refinance mortgage rate, you will be able to lock-in a rate. Variable HELOC rates means that you will be paying more interest if interest rates rise. Refinance mortgage rates are also generally lower than HELOC rates.
Yes, a mortgage refinance usually requires an appraisal. Since the amount that you are eligible to borrow in a mortgage refinance depends on the value of your home, most mortgage lenders will require a home appraisal to determine your current home value.