Looking to reduce your monthly mortgage payments, pay off outstanding debt or access some of the equity you’ve built up in your home? You may wish to consider mortgage refinancing.
Refinancing – paying off your current mortgage and taking out a new one – may enable you to take advantage of today’s historical low mortgage rates and flexible options. While there are costs involved, if you make an informed decision with a view to the long term, you could end up saving a considerable amount of money and stress. Managing your home equity along with your debt can be a key to a brighter financial future.
WHY REFINANCE?
1. Rate & Term Refinancing
For many people, the aim of refinancing is to lower their monthly payments, pay their mortgage down faster, or reduce the amount of interest on their loan. These homeowners generally wish to keep their loan amount the same, while simply changing the way they pay it off. This is called rate and term refinancing, and it may help you:
- To get a better interest rate.
If interest rates have fallen since you took out your mortgage, refinancing may enable you to get a better rate and lower monthly payments. For example, a $260,000 fixed rate mortgage with a 25 year amortization at 6 percent requires a monthly payment of $1,663. Lowering the rate to 4 percent drops the monthly payment to $1367.
- To save money on interest and build equity more quickly.
A recent change in your financial situation may make it possible for you to pay off your loan faster by increasing your monthly payments. Any extra money through a payment increase goes directly toward your mortgage principal therefore reducing interest charges.
- To reduce your monthly payments.
If you are having difficulty meeting your current monthly payments, you may wish to refinance your mortgage for a longer term. For example, if your initial mortgage was $220,000 at 6 percent for 25 years, your payment would be $1,407. Say you’ve owned your home for five years. You could refinance your remaining principal ($197,641.04) for 30 years at 4 percent, and your payment would drop to $ 939.82
2. Equity Takeout Refinancing
The other major category of refinancing and most popular involves taking out a new mortgage with a larger principal than the one you’re currently carrying. This is called equity takeout refinancing and its goal is to turn some of your home equity into cash. The equity in your home is essentially the difference between what your house is worth and what you currently owe on your mortgage balance. Since property values tend to increase over time, most people who have been in their home for an extended period of time may have a substantial amount of equity accumulated. For example, you may have paid $225,000 for your home but rising property values now make it worth $300,000. If you owe $180,000 on your mortgage, the equity in your property is now $120,000. Reasons to consider this type of refinancing include:
- To consolidate debt.
Most of us are carrying high interest debt (credit cards, unsecured lines of credit, bank loans, etc.) that would be better off refinanced into a low interest mortgage. The average Canadian homeowner currently owes about $35,000 in debt outside of their mortgage at an average carrying cost of 18 to 28% interest! Paying out these debts with new mortgage proceeds would free up monthly cash flow, as the extra payments towards these debts would be eliminated. The average person refinancing can save $500 – $1000 a month in payments and end up with a much improved monthly cash flow situation.
- To renovate
Whether you are thinking of renovating a kitchen, adding a new deck or finishing your basement, a home equity loan is a great way to finance your renovation project. Unsecured loans to acquire renovation financing often carry much higher interest rates and much shorter loan terms than traditional mortgages which mean higher monthly payments. Depending on how much equity you have built up, refinancing your mortgage and extending the terms of your loan may also lower your overall interest rate and potentially lower your monthly payment. Although you are initially removing equity in your home, with the reno-vation project you will also be improving the final value of your property.
- To free up money for a major expense like education.
You may have built up $180,000 in equity after 15 years of mortgage payments, and now you have two children whom you want to help put through University. Rather than taking out a personal loan which generally carries a higher interest rate, you can refinance your mortgage, adding $40,000 to the principal, and use that money for tuition.
IS REFINANCING RIGHT FOR YOU?
Before you determine whether refinancing makes financial sense, consider the following questions.
How long do you plan to be in your home? The benefits of refinancing add up over time, so if you’re planning to move in a year, any potential savings may be minimal. In general, the longer you plan to stay in your current home, the more sense it makes to consider refinancing.
What is the penalty for getting out of your existing mortgage? There will likely be a penalty to get out of your current mortgage. The amount varies, but it’s usually a small percentage of the outstanding balance based on your previous rate and today’s rate, or an amount equivalent to a certain number of monthly interest payments.
What are the costs of the new mortgage? There are costs associated with arranging a new mortgage. You will likely pay an appraisal fee and legal costs. Closing costs can be paid in different ways. Some homeowners add them to the amount they would like to refinance, rather than paying them in cash.
How much will you save? Refinancing a mortgage may be worth considering if the interest you’re now paying is at least half a percentage point higher than the new rate for which you qualify, assuming you’re going to remain in your home for the near future. But it’s important to be sure you’re not comparing apples and oranges. Deciding whether refinancing is worthwhile comes down to a simple question: How long will it take for the money you save with your new mortgage to exceed the costs of acquiring it?
How would your life change with better cash flow? If your debts were eliminated and you had an increased cash flow of $500 – $1000 a month how would that change your current life circumstance? What could you do with that extra money? Vacation, RRSP contribution and saving for children’s education may become much easier.
How much stress is your current financial situation causing? Many Canadians are feeling the crunch of financial stress. The number one cause for marital arguments in today’s society is money. Anxiety over money can negatively affect health in several ways like high blood pressure, depression and sleep problems.
