Refinancing a mortgage

Updated August 31, 2022

When you have a mortgage on your home, you usually need to renew it about every 5 years (give or take). Refinancing a mortgage isn’t the same as renewing it; when you refinance a mortgage, it means you’re renegotiating the terms of your loan agreement.

Why might you want to refinance your mortgage? There are a few reasons—read on to learn all about them.

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What is mortgage refinancing?

Mortgages include two different time periods you need to pay attention to: the amortization period and the term.

The amortization period is the total length of time it will take to repay the loan. In Canada, amortization periods are often as long as 30 years.

The mortgage term is the length of time during which you lock in your interest rate (whether a fixed or variable rate), payment terms, and so forth. The term is usually more like 5 years. At the end of each term, the borrower will renew their mortgage, meaning they’ll get new interest rates and payment terms for the next 5-year period.

Mortgage refinancing, on the other hand, means replacing the entire mortgage with a new one—new terms, new interest, a new principal amount, and so forth. Basically, you’re using the new mortgage to pay off the old one.

The upshot is that when you refinance a mortgage, you get access to some of the equity you’ve built up by paying your old mortgage over the years.

When should you refinance your mortgage?

Refinancing a mortgage is a big financial decision that no one should make lightly. That having been said, there are several reasons why someone would want to refinance their mortgage.

Getting a lower interest rate

Interest rates change constantly. If present interest rates are a lot lower than they were when you started your mortgage, you might be able to save money by refinancing into a new one. Of course, you can also get new interest rates by waiting for the end of your current term, but refinancing is another option.

Deciding if refinancing is worthwhile requires a little math. You need to figure out if the interest savings of a new mortgage will cover the costs of paying off your old mortgage early. Those costs include prepayment penalties and legal fees.

You can use an online mortgage refinance calculator to do the math for you.

Reducing your amortization period

If you’re making more money now than when you started your mortgage, you may want to accelerate the speed at which you’re paying it off.

Refinancing your mortgage into a new one with a shorter amortization period is one way to accomplish this. If your current mortgage is set to take 30 years to pay off, you can refinance it and get a new mortgage to be paid off in just 15 years (for example).

Accessing the equity in your home

One of the big reasons to refinance your mortgage is to get access to the equity you’ve built up in your home. Equity is the interest you have in your home—in the simplest terms, the market value minus what you still owe on your mortgage (or any other debts against your property). As you pay off your mortgage, your equity goes up.

You can cash out on that equity by refinancing your mortgage. When you refinance, you can take out a new mortgage that’s greater than the amount that you still owe and take the difference as cash.

Don’t think of it as free money, though; you’ll still need to repay the new mortgage. But, cashing out your home equity in this manner is one way to get a sizeable loan with reasonable interest rates.

People commonly refinance their mortgage to get some cash for:

  • Their children’s education
  • Major home renovations
  • Significant investment opportunities
  • Big-ticket purchases

Keep in mind:

You’ll typically need to have at least 20% equity in your home to qualify for a cash-out refinance. The amount you can take will often be limited to about 80% of your home’s appraised value (assuming you have that much equity to start with).

Consolidating debt

Similar to the cash-out refinance, some people refinance their mortgage in order to combine a number of different debts into a single mortgage. Most commonly, they use this strategy to pay down high-interest debts quickly.

When someone opts to consolidate their debt into a mortgage, they are still cashing out on the equity in their home. However, instead of pocketing the equity as cash, they use it to repay high-interest loans like credit cards.

Then, instead of making a bunch of different loan payments, they only need to worry about the mortgage.

Debt consolidation can help you get on top of various loan payments if they’re becoming a problem, or if you’re not making any headway against high interest rates.

But:

No one should view it as a Get Out of Jail Free card for debt. If you’re considering debt consolidation, speak with a financial planner to make sure you’re using credit wisely. It doesn’t help to consolidate your high-interest debts and then immediately go out and rack up new ones.

How much does mortgage refinancing cost?

The cost of refinancing a mortgage varies widely. Here are a few of the fees you’ll need to consider:

  • Prepayment penalty. Most mortgages include a penalty for paying them off early, which is what you’d be doing if you refinance. This is likely to be the largest fee you’ll pay, though the precise amount depends greatly on the terms of your mortgage. 3 months’ interest on the remaining balance is a common penalty.
  • Appraisal fees. Your mortgage lender might need your home to undergo a new appraisal. This can cost up to $500, and usually needs to be paid up front.
  • Discharge fees. If you’re switching to a different mortgage lender for your new mortgage, you’ll need to pay what’s known as a discharge fee—typically around $300.
  • Legal and registration fees. You’ll also need to have a real estate lawyer do a title search, register the new mortgage, and so on. These fees can add up; expect to pay up to $1,000. The good news? If your mortgage balance is greater than $200,000, your mortgage lender might cover the legal fees for you.

Want to learn more? Visit our Home Buying, Selling and Moving resource centre for everything you need to know about real estate, buying a home, or moving. Or, get an online quote in under 5 minutes and find out how affordable personalized home insurance can be.

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