This year’s home-buying season started with a bang when one of Canada’s major banks dropped its mortgage rate. These record-low rates are obviously appealing to people looking to buy their first home, and people looking to upgrade their current one. In addition, current homeowners with higher rates may also see an opportunity to refinance or remortgage their home and save some money. If you are looking to lock down a lower rate or pull equity from your current home, here are five things to consider before calling your lender:
1. Penalties for leaving your mortgage early
If you leave a closed mortgage early, you will likely incur a penalty. The penalty is usually the higher of the amount of interest you would pay in three months at your current rate, or the interest rate differential (IRD). The calculation of IRD can vary from lender to lender (and most major lenders also offer penalty calculators on their websites), but it is generally an estimate of the amount of interest the lender would receive on your remaining principal, based on current rates. For example, if you have two years left, the IRD would be the interest amount at the current two-year rate, although the rate might be based on the mortgage-qualifying rate – the current five-year posted rate published by the Bank of Canada.
Along with the penalty, other fees may apply when exiting your mortgage early, such as administration fees and an amount equal to any initial discount on the rate you received. Ask your current lender to calculate the costs you can expect to pay.
If the penalty for leaving your mortgage early is more than the amount you will save by refinancing, you may not be better off refinancing. Our mortgage calculator can help you figure out some of the math.
2. Refinancing vs. using a home equity line of credit
If you need money to cover an expense – such as a home renovation, second property, education fees, debt consolidation or other costs – you have a few options. You can refinance your existing mortgage or use a home equity line of credit (HELOC). Both allow you to access the equity in your home, but have different features.
- Refinancing – You can borrow up to 80% of the appraised value of your home, less the current balance of your mortgage. For example, if you owe $200,000 on a home appraised at $400,000, you can borrow an extra $120,000. Your new mortgage total would be $320,000.
- HELOC – You can borrow up to 65% of the appraised value of your home, with the total of the line of credit and your mortgage amount adding up to a maximum of 80% of the home’s value. For example, you can borrow a maximum of $260,000 on a home worth $400,000, but if you owe $200,000 on your mortgage, you can only borrow another $120,000 ($200,000 + $120,000 = $320,000, or 80% of your home’s value). However, unlike the refinancing option, the amount that you can borrow with a HELOC is adjusted as your pay off more of your mortgage.
Both options may come with additional costs, such as administrative, appraisal and legal fees. In addition, you may not get the same rate on your current mortgage as you do on the refinanced amount or the HELOC. Visit the Financial Consumer Agency of Canada for more information about this.
3. Avoid unnecessary mortgage additions
In low-interest periods, the option to refinance is tempting. However, consider that using your home equity means that you’ll be paying for that home renovation or debt consolidation for the life of your mortgage. If the value of your home decreases, there is a risk that you’ll owe more than your house is worth if and when you decide to sell. Can your renovation wait a year or two? Do you have some areas in your budget that you could cut to help pay off credit card debt or save for other expenses? Ultimately, debt acquired at a low interest rate is still debt – and will still cost you something. If you decide to refinance your home or get a home equity line of credit, only borrow what you need.
4. Do you have good credit?
Lenders may add a premium to your rate if they consider you a credit risk. As a result, you may not be able to get the lowest rate on refinancing options. Lenders may also offer a different rate if your income or employment situation has changed since your current mortgage began.
5. Shop around
You don’t have to stay with your current mortgage lender when you refinance. You may be able to find a better rate elsewhere. Start looking a few months ahead of your mortgage expiry
date – you may be able to hold a rate, or your current lender may be able to match a lower rate.
Choosing a mortgage that’s right for you can greatly impact your immediate and long-term finances. Before refinancing a mortgage or taking on any new debt, check the terms of your current commitment and compare your options. Give us a call and we will help you with this at 519-434-0449.