What is the point of refinancing?
Whether you’re looking to save on interest over the coming years or reduce your payments now, refinancing can help.
“Many Canadians are finding it difficult to manage their monthly debt payments during COVID-19,” says Reza Sabour, a senior adviser and director with the Canadian Mortgage Brokers Association of B.C.
When you refinance, you open a new, better loan and use it to pay off your existing mortgage. You’ll have to pay a penalty for breaking your old agreement, but this single financial move can make a huge difference if you’re struggling to pay your bills.
“This not only saves the client a lot of money in interest costs but could also help protect their credit score if they have fallen behind in making their minimum payments,” Sabour adds.
However, Sabour cautions against cash-out refinancing, in which you get a bigger loan than you need to cover your existing mortgage. Refinancing is not a free-for-all where you tap into your equity and live large, he says; it’s more about creating a new financial plan that will help you save and succeed.
How do I know if I should refinance?
If your mortgage rate is higher than 3% — or 0.75% higher than the rates you can get now — you’ll definitely want to calculate your potential savings.
Let’s imagine you have a $500,000 mortgage with a 4% fixed rate and an amortization of 20 years. The total interest you’d pay over a five-year term would be $90,634.
The interest for that same mortgage at 2.69% would be $60,374. So by refinancing, you’d save $329 per month, $6,392 per year and $31,960 over the full length of your five-year term.
That extra financial wiggle room can free up cash for an emergency fund or help you afford the essentials while the economy — and maybe even your own job security — remains uncertain.
Unfortunately, anyone who has lost their job due to the coronavirus lockdown will struggle to qualify for refinancing. Since you’re opening a totally new loan, you have to provide evidence that you can make regular payments.
If you’re denied, you’ll need to look elsewhere for support. Lenders are allowing homeowners to defer their mortgage payments during this trying time, but it’s not a perfect solution. In most cases, those loans will continue to generate interest while on pause.
When is refinancing a bad idea?
Both Sabour and Geddes advise staying with your existing mortgage if the potential savings is less than the cost of breaking your current contract.
Penalties can cost up to 4% of a fixed-rate mortgage or three months of interest payments in a variable contract, Reza says, but you’ll have to check with your lender.
And remember that if you want a great deal, you’ll probably need a credit score of at least 660. You can check your credit score and credit report for free online; if your score is low, it’s not a bad idea to try to boost your numbers before you lock in a new rate.
How do I choose the best option?
When buying a home or refinancing, you need to think about both your income and your financial comfort zone.
Conservative personalities will prefer a fixed rate and pay a bit more for peace of mind and a predictable monthly budget. If the prime rate rises during your term, you won’t pay a penny more.
If you want the best bargain possible, a variable rate tends to be the better choice.
“From a purely math perspective, variable is the way to go right now and has generally been the product that wins the tug-of-war” when you look at trends over time, says Sabour.
If you’re flirting with a variable rate, remember that you can ask about converting to a fixed rate in the future. If interest rates start to increase during your term, Sabour says, you can make the switch without penalties or extra costs.
Major banks are offering variable rates as low as 2.25% right now, while fixed-rate mortgages start at 2.54%.
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