Refinancing is a tool that many Canadians use to combine their debts to benefit from lower interest rates, and reducing the number of payments that they make each month.
Refinancing is a process of obtaining a new mortgage; by changing the terms on the mortgage that you already have in place on your home. You maybe thinking of refinancing your mortgage for a few reasons; like taking advantage of lower interest rates, changing mortgage companies, reducing monthly payments, or using money from refinancing to fund big projects; like home renovations or buying that dream vacation home. You do not end up with two mortgages; as the first loan is technically paid off through the refinancing, and the second loan is created in its place.
Just like your current mortgage you need to contact a Mortgage Broker and apply for a loan and be approved to qualify for refinancing. There is a chance that you could be denied if the lender feels that you are at risk. One word of advice would be to check your credit rating: if your credit score has decreased, you may not get the best rate.
When lenders review your application, they also review your debt i.e. the Gross Debt Service ratio and Total Debt Service ratio. The Gross Debt Service measures how much of your gross income is needed in order to pay your monthly housing, and your Gross Debt Service typically needs to be under 32% to qualify.
The Total Debt Service ratio is the percentage of your gross income that is needed to cover your debt payments. It includes the cost of the home (mortgage, property tax, heating bills, and condo fees, if they apply) plus your other debts like credit cards, car repayments, lines of credit, etc. Your Total Debt Service ratio typically should be 40% or less.
Both ratios do play a major role in how much the lender will loan you. If you have a high ratio, you are more than likely to be approved for a smaller loan.
Another factor in refinancing is your current equity; meaning how much of your mortgage have you paid off to date and the current market value of your home. You can borrow as much as 80% of the current value of your home minus the amount owing on your mortgage.
Before you consider refinancing, you need to understand the costs. Are you breaking your mortgage agreement before the term has ended: as you may have to pay a penalty? Generally, it’s equal to three months of interest. You also have the cost of a home appraisal, as the lender will require one to obtain the current market value on your home.
One of the most common reasons for Canadians to refinance is the lower interest rate. When you think about how much money you can save from an interest rate that is one percent lower than your current rate. The long-term effect is worth it, as you will save a couple of hundred dollars each month to add to that rainy-day fund. It also means that you are locking in a lower rate of interest at a fixed rate or reducing your mortgage term length.
Also, if you are trying to pay off multiple credit cards and other high-interest debts, it may be a wise decision to refinance and consolidate your debts into one payment; as a mortgage also carries a much lower interest rate than unsecured debts i.e. credit cards.
Refinancing is a tool that can be worthwhile if you are planning on keeping your home for many years, as the lower interest rate you took advantage of has paid off.