Things to know before refinancing your mortgage

By: Zandile Chiwanza on February 25, 2020

Did you know that as a homeowner, you can pay off your current mortgage with a new one that has more favourable terms and conditions?

Refinancing is a great way to lower your interest rate, consolidate and pay off debts, or even tap some of the equity in your home. 

If the mortgage lender agrees, you can borrow up to 80% of the appraised value of your home, minus what you have left to pay on your mortgage. For example, your house market value is worth $300,000 but you still owe $175,000 on your mortgage. If your lender agrees to refinance your home to the $65,000 limit, you'd owe a total of $240,000 on your mortgage.

If you’ve built up extra equity in your home, you can apply for a mortgage that’s bigger than the one you want to discharge and use the difference for home renovations, to make a big purchase or maximize your investments.

Calculate your available equity and find out how much you may qualify to borrow before you decide whether or not to refinance your current mortgage.

Here’s what else you need to know.

Your credit score and debt-to-income ratio

In order to qualify for a refinanced mortgage loan at a bank, the potential lender will look at your monthly income, current level of debt and credit report. You may need to provide proof of employment, proof you can pay for the down payment and closing costs, information about your other assets, information about your debts or financial obligations and notices of assessments from the Canada Revenue Agency (CRA) for the past two years if you're self-employed. 

While lenders require high credit scores for the best interest rates and terms, homeowners with bad credit can refinance their mortgage, too. The lender may suggest adding a cosigner, only consider your application if you have a large down payment or decide to approve it for a lower amount or at a higher interest rate. 

The costs 

Can you afford the additional debt load and new payments? Don’t forget to factor in fees before you decide if refinancing works for you. 

The major disadvantage to refinancing is the large penalty you may have to pay your lender if you break your mortgage term early. If you are switching lenders, you’ll need to pay a fee to discharge your mortgage from your current lender.  

Additional administrative fees may include:

  • Legal fees. When you refinance your mortgage, you’ll need to consult with a real estate lawyer. 
  • Mortgage registration fee. Whether you leave or stay with your current lender, you will have to pay a mortgage registration fee. 
  • Insurance. You may also have to pay a new mortgage loan insurance premium if your existing mortgage amount is modified.
  • Closing costs.
  • Appraisal and inspection fees.

The risks

Interest rates on loans secured with home equity can be much lower than other types of loans such as a personal loan or a credit card. However, there are extra fees when you use your home as collateral for a loan. For example, if you switch from a fixed-rate mortgage to a variable-rate mortgage, you may deal with rising interest rates and higher monthly payments in the future. 

There is also the risk that the market value of your home could change over time, and fall below your outstanding mortgage amount.

Another risk to consider is if you want to switch lenders and your new lender is a bank, you may need to re-qualify for the stress test.

Finally, since one lump sum is deposited to your bank account as a new loan to replace the existing one, there is the risk of falling into a debt trap and falling behind on your monthly mortgage payments. 

Make sure you don’t wait until you receive the renewal letter from your lender or mortgage broker to find a refinancing plan that fits your unique financial needs. Consider multiple lenders and compare refinance offers long before the end of your mortgage term.