Barry Choi
Mary Flory
Refinancing replaces a homeowner’s current mortgage with a new one, typically to meet financial needs or take advantage of lower interest rates. While refinancing often means breaking the existing mortgage and paying a prepayment penalty, it could be worthwhile if you get a lower interest rate, tap into your home equity or consolidate debt.
While the benefits of refinancing can sometimes be clear, not all situations may be so straightforward. If you’re asking yourself, “Should I refinance my mortgage?,” here’s what to consider as you make your decision.
Requirements for a successful refinance
When considering a mortgage refinance, think about these requirements before you start filling out loan applications with your current or a new lender. Understanding these factors could help make your decision much easier.
Time left in loan
The amount of time left in your mortgage term could significantly impact your bottom line when refinancing. That’s because you’ll need to break your existing mortgage in order to do so. Depending on your mortgage agreement and lender, you might be charged a prepayment penalty based on the interest rate differential (IRD), which is calculated using the number of months you have left in your mortgage term. If you still have years left in your term, the prepayment penalty could be quite high, which could negate any potential savings offered by lower interest rates.
Sufficient equity
Generally, you can borrow up to 80% of the appraised value of your home. Once you’ve calculated that amount, you need to subtract any existing mortgage balance and the balance of any loans secured against your home, including a home equity loan or line of credit (HELOC).
For example, say your home is worth $400,000. Refinancing could give you access to up to 80%, or $320,000 — if you owned your home outright. However, if your outstanding mortgage balance is $250,000, that means you could borrow up to $70,000 as part of a refinance.
Typically, you need to have a loan-to-value (LTV) ratio of less than 80%, which means at least 20% equity in your home, to qualify for mortgage refinancing.
Competitive rates
Often, you may start to consider refinancing when interest rates have fallen since you took out your existing mortgage. For example, say you’re three years into a five-year fixed-rate mortgage at 6%, and rates are now around 3%. Even though you’d have to pay a prepayment penalty, it could be worth refinancing for a lower rate since you might save more money in the long run — though you’ll need to crunch the numbers and compare mortgage refinance rates to be sure.
Ability to requalify for a new loan
Refinancing a home is similar to getting a new mortgage in that you need to qualify for the new loan. As part of assessing your application, lenders will check your income, debt service ratios and credit history. You also will need to pass the mortgage stress test with your current debt loads. If you don’t meet their requirements, you may not get the best rates — or be approved at all.
Common questions about refinancing
Even if you meet the requirements to refinance your mortgage, there’s no reason to rush into things. First, ask yourself why you’re considering these options, and whether a refinance is the best way to meet your goals.
Should I refinance my mortgage to pay off debt?
Refinancing your mortgage to pay off other debt can sometimes make sense. That’s because your mortgage is a form of secured debt, so you’ll usually get access to lower interest rates compared to other forms of debt, such as a personal line of credit. Consolidating your debt into a refinanced mortgage can potentially help you save money, and can also mean you only need to manage one bill payment.
Let’s say you have high-interest debt, such as credit card balances or a personal loan. Refinancing your mortgage could allow you to borrow enough money to immediately pay off that high-interest debt. This strategy would leave you with the same amount of debt, but consolidated into one loan (your mortgage) with a lower interest rate.
Should I refinance my mortgage for a lower interest rate?
When interest rates drop, the savings you could get from refinancing your mortgage could make it worth breaking your existing mortgage. Most lenders have online calculators, so you can quickly determine what penalties you would pay to break your mortgage and refinance. If the overall savings appear to be significant, it may be worth looking more seriously at refinancing.
Should I refinance my mortgage for home improvements?
Refinancing your mortgage to free up cash to pay for home improvements can be worth it if you have equity built in your home but limited savings. The interest rate offered by refinancing is typically lower than that on credit cards and personal loans. Refinancing could allow you to renovate your home while potentially improving its value of your home. Again, it’s a good idea to compare the costs of refinancing to those of other borrowing options, such as a home equity loan or HELOC.
Should I refinance now?
The decision if and when to refinance is a personal one and should be based on whether you qualify for refinancing and your reasons for doing so. When interest rates are lower than they were when you took out your existing mortgage, refinancing may be a good idea, since it could save you money in interest in the long term. However, in an environment of rising interest rates, such as the situation in Canada in 2023, refinancing may not be as beneficial.
Another reason to consider refinancing is your budget. If you lack cash flow or you’re paying high-interest debt, refinancing could give you access to the equity you’ve built in your home. Making use of this equity could help you consolidate debt or manage your household budget a little more easily.
That said, refinancing to borrow more money is sometimes compared to treating your home like an ATM, which is not ideal because you’ll eventually need to pay those funds back. In addition, refinancing comes with many fees, such as legal fees, a home appraisal, mortgage registration, prepayment penalties and more. You’ll need to figure these costs into your calculations when deciding whether it’s worth refinancing your mortgage.
Frequently asked questions about refinancing a mortgage
In most cases, people choose to refinance for three reasons:
- To get a lower interest rate.
- To access equity in their home.
- To consolidate debt.
If you’re thinking about any of these situations, it may be worth considering a refinance. But first, make sure you meet typical refinancing requirements and check your mortgage agreement to understand the potential costs of breaking your existing mortgage.
You can refinance your mortgage whenever you want, as long as you meet the eligibility requirements. That said, you likely should only do so if you have a specific reason in mind. Refinancing comes with costs like prepayment charges and other fees. It could also potentially extend the length of time it takes to pay off your mortgage and even cost you more in interest over the full repayment period.
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