How Does Home Refinancing Work in Canada?
(And Why You Should Consider it)
What is Refinancing?
Simply speaking, Refinancing is the replacement of an existing loan with another debt, usually under a different term and interest rate. In addition, this new debt may have a higher principal amount to borrow more money.
The new loan can save money, consolidate debt or help meet other financial obligations. In most cases, refinances are used to reduce the current interest rate or pay off the debt, thereby saving money.
As a property owner, you can choose a mortgage refinance to extend the loan term to pay off the debt sooner.
Refinancing a Mortgage in Canada
According to the Canadian Mortgage and Housing Corporation (CMHC), mortgage refinancing allows many homeowners to pay their existing mortgage in full by securing another home loan.
Your home is an investment, and a refinance mortgage is a convenient method to use your home equity for leveraging that investment. You may decide to do this for a few reasons including borrowing more money, generating a cash flow from your property, lowering your mortgage payment, and shortening your loan term.
The Refinancing Process
When you refinance the mortgage on your house, you’re essentially trading in your current mortgage for a better one. A refinanced loan gives the homeowner a choice of interest rates and terms and the option of borrowing from their home equity.
A few more details
You can use a cash-out refinance to use your home’s equity or a rate-and-term refinance to get a better interest rate and lower monthly payments. You can change your adjustable rate mortgage to a fixed rate mortgage, where the interest rates do not change until the mortgage term is over.
In Canada, you can refinance to borrow up to 80% of the value of your home, though you will need to pass a mortgage stress test. Although getting a mortgage refinanced is less complicated than the home buying process, the refinance process will take about 30 to 45 days.
So, how does refinancing work?
Let’s look at how refinancing a mortgage works, so you know what to expect and can make an informed decision.
Is Refinancing Your Mortgage the Best Option For You?
You will first need to determine whether a mortgage refinance is the right option for you. Remember that refinancing costs are relatively steep; you are required to pay home appraisal fees, mortgage registration and legal fees when you replace your current mortgage with a new one.
The table below lists the fees and penalties that need to be paid, though a few need to be paid only under specific circumstances.
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Therefore, you must check to see if the potential savings outweigh any refinance closing costs or penalties you would have to pay. An important point to remember, your refinanced mortgage can’t exceed 80% of your home value.
Another reason homeowners refinance their mortgages is to consolidate their debts, especially higher-interest loans such as car loans, personal loans, credit card debt, or even a second mortgage. The cost of refinancing versus the expense of other loans is another decision you must make.
Do Your Research
Once you decide to refinance your mortgage loan, you will also have a fair idea about what you want to change in the existing loan. The next step is researching different mortgage lenders; don’t be afraid to shop around and compare each lender’s mortgage interest rates, availability, and client satisfaction scores.
Opting for a Different Mortgage Lender
You do not necessarily have to refinance a new loan with your current lender. Other lenders may offer lower mortgage refinance rates or monthly mortgage payments. If your current loan is a variable-rate mortgage and you think interest payments may increase significantly in the near future, you can switch to a fixed-rate mortgage to lock in a lower interest rate.
Apply for Refinance
When you apply for a mortgage refinance, you will be asked to share financial information such as your pay slips, tax returns, and bank statements. They will assess your income, assets, debts, and credit score to ascertain whether you meet the requirements for refinance and can repay the loan.
Having your tax returns handy for the last several years is a good idea, especially if you are self-employed, as you might be asked for more income documentation.
Mortgage Stress Test
In all cases, you will need to pass the mortgage stress test on your new refinanced mortgage balance. Refinancing a mortgage is essentially a new loan, which means that your mortgage refinance lender will insist that you pass the stress test for mortgage approval.
A bad credit report will make it difficult to be approved for a mortgage refinance from a major bank. Lenders use your credit score to determine the mortgage loans you can get; improving your credit report will benefit you beyond lower mortgage rates.
Mortgage Refinancing Rates
Generally speaking, refinance rates are higher than those offered for a new home loan or a conventional loan. This is because refinances pose a greater risk for mortgage lenders, as you borrow more money.
Locking in Your Interest Rate
Once the loan is initially approved, you have the option of locking in the interest rate; this means that the interest rate will not change between the dates of offer and closing. Of course, the rates hold good only if you close within the specified time frame and there are no changes to your application.
A rate lock can last anywhere from 15 to 120 days, depending on your location, loan type, and lender. You may get a better deal if you lock in the rate for a shorter period, you may get a better deal.
You may also decide to float your rate, which means not locking it before proceeding with the loan, but this feature puts you at risk of getting a higher rate.
If you’re happy with the mortgage interest rates at the time of application, then you should go ahead and lock the rate.
The underwriting process starts with the submission of your application.
Underwriting is the verification of your credit history, income, assets, debt, and property details by the lender before the final approval for new mortgage loans. When underwriting the application, your mortgage lender verifies your financial information according to the three C’s (credit, capacity, and collateral) and ensures that everything you’ve submitted is accurate.
Your application can be rejected if they discover major changes to your credit, income, or cash to close. Therefore, it is a good idea to ensure that you have authentic paperwork that proves your collateral and financial information.
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An essential part of underwriting is a home appraisal. Since the amount that you are eligible to borrow depends on the value of your home, a home appraisal is required to determine your current home value. The assessment also determines what loan options are available to you.
The lender will verify the details of your property and arrange an appraisal to determine the home’s value. It is a good idea to make sure your home is tidy, and that any minor repairs are fixed. Make a list of upgrades you’ve made to the home since you bought it.
If you are hoping for a cash-out refinancing, the value of your home determines how much money you can get. If you’re trying for a lower monthly payment, then the appraisal value tells you whether you have enough home equity to be eligible.
Lower, Equal, or Higher Appraisal Estimate
If the estimate is lower than you requested, you can cancel your application or lower the refinance amount. Another alternative is a cash-in refinance, where you bring cash to the table – this is a good option when you are lower than your loan or want to get rid of private mortgage insurance premiums.
The new mortgage loan will be approved if your home’s appraisal is equal to or higher than the refinance loan amount you want, the new mortgage loan will be approved.
Closing on Your New Loan
Once the underwriting and home appraisal are complete and approved, your lender will send you a Closing Disclosure with the final numbers of your loan.
You will review the details when closing on your new home loan and sign the documents. Any closing costs not included in your loan should be paid now. If your lender owes you money, in the case of a cash-out refinance, you will receive the funds after closing.
You have a grace period before being locked into the new mortgage loan. If you need to cancel the refinance for any reason, you can do this any time before the grace period ends.
The Top 4 Advantages of a Refinance Mortgage
Now, let us discuss why refinancing your mortgage is a good idea. There are several reasons why homeowners choose to go through the refinance process.
The top four advantages are:
- Change Your Loan Term
You can either shorten or lengthen your loan term.
For example, you shorten your 30-year loan to a 15-year or 20-year rate and term mortgage. But can now afford a higher mortgage payment. You save money by getting a better interest rate and paying less interest, but with higher monthly payments
On the other hand, if you lengthen your loan term, you can potentially lower your monthly payment.
- Lower Your Interest Rate
Refinancing might make sense if your credit score has improved or the current interest rate is more favorable. A lower interest rate can reduce your monthly payment, and you’ll pay less interest over the life of your loan.
You can do this through what’s called a rate-and-term refinance loan.
- Change Your Loan Type
There are several reasons why a different type of loan may benefit you. If your current loan is an adjustable-rate mortgage, you may switch your loan to a fixed rate; this helps you avoid the impact of market fluctuations.
Or, you have a variable-rate mortgage and want to switch to a fixed-rate mortgage to lock in a lower rate today.
Either way, you can select the lower mortgage interest rate.
- Cash Out Your Equity
If you have significant equity in your home, you can use a cash-out refinance to take advantage of it. Many homeowners do this to consolidate debts, finance home improvements, or make investments.
With cash-out refinances, you borrow more than you owe on your home and retain the difference as cash. Using cash from your home equity allows you to borrow money at a low-interest rate.
Cutting a Long Story Short
The bottom line is that refinancing can make your home equity work for you and borrow money cheaply. A mortgage refinance is best suited for homeowners that have home equity and are looking to borrow a large amount at a fixed rate.
When you feel the time is right, refinancing is a cost-effective way of using your home as a financial tool. Just make sure you weigh up all the numbers before you do it.