Everything you need to know about refinancing your mortgage
If you are considering refinancing your mortgage or if someone has recommended that you should, you probably have a lot of questions about what exactly that means and what it involves. Refinancing your mortgage can be a great way to lower your interest rate, pay off your home loan faster, or even to borrow money from the equity in your home.
But before you go ahead with such a strategy, it is important that you understand what you are doing and why you are doing it. In this blog, we will review what you need to know about refinancing your mortgage.
What is a mortgage refinance?
Refinancing your mortgage means that you are breaking your current mortgage and replacing it with another one. In most cases, your new mortgage will be at a lower interest rate than the mortgage you broke. But because you are breaking your first mortgage, you will most likely have to pay a financial penalty. For this reason, it is very important to work with a qualified mortgage broker who can help you determine whether a mortgage refinance will save you enough money in the long run to make it worth paying the penalty.
If you have enough home equity however, the cost of the penalty can usually be rolled up into the new mortgage so that you are not paying it all up front. Talk to your mortgage broker about whether this would be an option for you.
If you recently renewed your mortgage, then the financial penalty that you would have to pay on a mortgage refinance will be much higher. In this situation, your mortgage broker may recommend alternative strategies such as a second mortgage instead.
When should you refinance your mortgage?
There are many reasons why a homeowner might choose to refinance their mortgage. Some of the most common reasons are as follows:
- To lower your interest rate. Even a seemingly small percentage in interest savings can equate to thousands of dollars saved over the time that you hold your mortgage. If interest rates have dropped substantially since you got your current mortgage, you may want to look into how much you might save with a mortgage refinance. You may also be eligible for a lower rate if you current mortgage is a bad credit mortgage or a self-employed mortgage but you have since improved your credit rating for financial situation.
- To change the terms of your mortgage. While most people fixate on their mortgage rate, it is also important to pay attention to the terms of your mortgage. Depending on your financial capabilities, it may be in your best interest to lengthen your amortization period so you are paying less on your mortgage payments – or to shorten your amortization period so that you can pay off your home more quickly.
- To change the type of your mortgage. Another reason to refinance your mortgage is to switch from a fixed rate mortgage to a variable rate mortgage or vice versa. With a fixed rate mortgage, you will get more stability and predictability, but with a variable rate mortgage, you may get more flexibility and possibly a lower interest rate.
- To consolidate debt or borrow from your home equity. If you have equity in your home that you would like to borrow from, a popular way to do that is with a mortgage refinance. When you refinance your mortgage in order to borrow equity, your new mortgage will be for the amount you owed on your original mortgage plus the amount of cash that you borrowed from your home equity. Most lenders will allow you to borrow up to 80% of your home equity.
- To change lenders. If you are unhappy with your current lender for any reason, a mortgage refinance is usually a simple way to make a switch.
Advantages of mortgage refinancing
Depending on the reason you wish to refinance, you can realize a number of benefits using this financial strategy including:
- Lowering your interest payments.
- Altering the terms or type of your mortgage.
- Paying off your mortgage faster.
- Lowering your mortgage/debt payments.
- Consolidating your debts and getting out of debt faster.
- Funding a major project such as a home renovation and starting a business.
- Leaving a lender that you are unhappy with.
What is the right time to refinance your mortgage?
Although refinancing your mortgage can be a powerful financial strategy, timing is important. As we discussed earlier, when you break your first mortgage you are going to have to pay a financial penalty. Usually, the closer you are to your mortgage renewal date, the lower this penalty will be. Therefore, mortgage refinancing will always be more attractive to those approaching their mortgage renewal date than it will be for those who only recently renewed.
If you are discussing a mortgage refinance with your mortgage broker, they will run some calculations for you to determine whether refinancing your mortgage makes financial sense for you.
If it does, they can help you begin the process. If not, they can recommend other financial strategies that might work better for your situation.
Knowing how much equity you have in your home
Whether you intend to borrow equity from your home or not when you refinance, you will find that refinancing is usually easier to do if you have at least 20% equity in your home.
To determine how much equity you have in your home, you will need to subtract how much you still owe on your home from your home’s value. Keep in mind, that your home’s equity can in increase in two ways. The first way is by you paying down your mortgage – the second way is that the value of your home increases because the price of real estate is increasing.
To get a rough idea of the current value of your home, you can look at what homes similar to yours are selling for in your neighbourhood. Of course, most lenders are going to want more than a “rough idea” so at some point, if you are borrowing equity, you will have to get a home appraisal.
Borrowing equity from your home.
When you refinance your mortgage, it is a good time to borrow equity from your home if you need to. Most lenders will allow you to borrow up to 80% of your home’s equity when you refinance your mortgage. That means that if you have a home that is valued at $500,000 and you still owe $200,000 on your mortgage, you have home equity value of $300,000 which would make you eligible to borrow up to $240,000.
When homeowners refinance their mortgages, they often borrow from their home equity in order to consolidate debt or to pay for a large expense. This can be a very smart way to borrow because the interest rate on this type of debt is usually much less than on unsecured debts such as credit cards.
Of course, the drawback to borrowing from your home equity is that you are borrowing against your home and you could be putting yourself at risk of losing your home if you become unable to make the payments. For this reason, it is important to carefully go through your budget to ensure making the minimum monthly mortgage payment will not be a problem.
If you are borrowing from your home equity in order to consolidate debt, you should make a commitment not to rack up your credit cards and other debts again – otherwise you could find yourself in a worse position than you were in prior to the refinance.
What are the documents required to refinance your mortgage?
The answer to this question will depend in part on which lender you are looking to refinance with. If you wish to refinance with a traditional lender such as a bank, you will need things such as asset and liability statements, proof of income, your T4, etc. If you are self-employed, you may also need additional documentation such as your business credit rating, and purchase order to show that you have more income coming in.
Especially if you are borrowing from your home equity, you will also need to prove the value of your home – since that has likely gone up in recent years. This will likely require you to get a professional appraisal at an additional cost.
If you are refinancing with a non-traditional lender, chances are that the documentation requirements will be less strict however you should still be prepared to provide some kind of proof that you will be able to make your regular mortgage payments.
When it is time to make a formal application for your new mortgage, you mortgage broker will provide you with a checklist of exactly what documents you will need.
Debt to income ratio
Most homeowners assume that since they’ve already been approved for a mortgage, it should be no problem to refinance the mortgage that they already have.
The problem with this way of thinking is that many lenders (especially the federally regulated lenders) have much stricter requirements for home loans than they did only a few years ago. Your debt to income ratio is a big part of making this determination.
Generally speaking, lenders want to see that you don’t have more than 28% of your income going toward housing costs.
You may still be able to qualify for a mortgage refinance with a B lender or specialty lender if you cannot do it with an A lender, as these lenders are usually more lenient on their requirements.
A professional mortgage broker has business relationships with many different types of lenders and by working with a broker, you can have confidence that the lender you eventually decide to work with will be someone reputable.
What should you look for when you refinance your mortgage?
If you have made the decision to refinance your mortgage, there are a few things that you should be on the lookout for to make sure that you reap the maximum benefits of this financial strategy.
You should look for:
- A knowledgeable mortgage broker. There is no point in refinancing your mortgage unless it is ultimately going to put you in a better financial position than you were before. If you are paying less interest but your savings was offset by the financial penalty, or if there are terms in your new mortgage that are unfavourable, then refinancing may not help you the way you hoped. Having a knowledgeable mortgage broker who can help you through the process and help you select the lender and type of mortgage that make the most sense for you is imperative if you want this strategy to work.
- A good interest rate. Right now interest rates are at an all time low and the more you can save on interest when you refinance, the easier it will be to make your mortgage payments and the faster you will be able to get out of debt. If you do not have a good credit score, you may not be able to get the best rate that is currently be offered, but if you are going to refinance, you should still get a better rate than what you are currently paying on your mortgage.
- Favourable terms. Your needs may have changed since you got your current mortgage. If you are in the process of refinancing, talk to your mortgage broker about whether you should be thinking about changing the terms of your mortgage as well. Perhaps you want to shorten or lengthen your amortization period, or switch from a fixed rate mortgage to a variable rate mortgage. If you are refinancing, now is the time to examine the terms of your current mortgage and determine whether or not they are still meeting your needs.
Is a mortgage refinance right for you?
If you think that a mortgage refinance might be the financial strategy for you, we would love to help. Contact Matrix Mortgage Global today to speak with one of our agents.