How To Refinance A Mortgage

Has your credit score improved since you took out your mortgage? Are you looking to lower your payments and save money? A mortgage refinance might be exactly what you need to create some space in your budget. Keeping reading to learn how to refinancing your mortgage.

What Does It Mean To Refinance A Mortgage?

Refinancing your mortgage loan basically means taking out a new loan with different terms to pay off the original mortgage. Basically, this means you get rid of your original mortgage by paying it off with the new loan. After that, you’ll make payments toward your new loan instead.

With a mortgage refinance you can choose to: 

• Refinance a mortgage with a lower interest rate and longer-term (or shorter term). 
• Change your mortgage from a fixed-rate to a variable-rate mortgage. Or vice versa. 
• Access the equity in your home by choosing a cash-out refinance. With this option, you’ll take out a mortgage that is higher than what you owe on your current mortgage. That way you can use the difference to consolidate debt or re-invest in the property through renovations.

What Do You Need To Qualify For Mortgage Refinancing?

In order to qualify for refinancing you’ll need to meet a couple of requirements. In general, lenders will look at the following criteria: 

• LTV Ratio or Equity –  A LTV ratio lower than 80% (or a home with 20% equity). This is calculated by dividing the balance left on your mortgage plus any other debts secured by your property by the current value of your property. 
• Your TDS Ratio – Your lender will also evaluate your income and current debt or your service debt ratio. Lenders generally require your mortgage payments to be less than 32% of your gross income and your overall debts to be no more than 40% of your gross income.  
• Credit Score – Most lenders, particularly banks, will require a credit score of at least 650. Though alternative mortgage lenders may be more flexible with their credit score requirements, it’s best to refinance with good credit. As such, it’s important to check your credit score and see if it needs improvement before applying for a mortgage refinance. 

Steps On How To Refinance A Mortgage

If you decide to refinance your mortgage, there are a few steps you’ll need to take to complete the process.

1. Complete Your Application To Refinance

When you refinance, you’ll need to provide your lender with a new loan application and relevant documents so your lender can assess your eligibility. Before applying be sure to evaluate your finances and ensure you meet the lender’s minimum requirements. This may include a threshold for credit scores, debt levels, income levels and the amount of equity in your home. 

Documents Needed To Refinance A Mortgage

Your lender may require proof of income, proof of employment, and tax documents such as your Notice of Assessment (NOA). Lenders may also require you to provide certain documents for verification such as a T4 slip, pay stubs, bank statements, mortgage statements, and property tax bills. 

2. Compare Options

Be sure to compare your mortgage refinance options before choosing to work with any one lender.  For consumers struggling with their credit, working with a mortgage broker who can match you with a great B-lender is a great option. 

In fact, whether you have good or bad credit, a mortgage broker can help you sort through multiple lenders and help you find the best deal for your financial situation. 

3. Wait For A Response

Once you fill out the application and provide all the necessary documents, your lender will begin the underwriting process. If you’re approved, your lender will send you a document with all the terms and conditions of the loan.

4. Review the Agreement 

Before signing the agreement, be sure to review the details of the loan such as the payments, interest, fees and penalties for late payments or prepayments. If you’re happy with the contents of the loan, simply sign the agreement to seal the deal.

What Are The Costs To Refinance A Mortgage? 

Before deciding to refinance your mortgage, do make sure to factor in the fees. When you refinance, you’ll have to pay legal fees, appraisal fees, administration fees, prepayment penalties and potentially a discharge fee if you decide to switch lenders. Moreover, if you break a mortgage contract earlier there’s usually a fee for that as well. In general, when you break a mortgage early, you’ll be charged around 3 months of interest or the interest rate differential (IRD) penalty, whichever is more. 

What Are The Pros Of Refinancing A Mortgage?

• Lower Monthly Payments – Refinancing a loan may increase the length of your term but will result in lower interest rates and more monthly cash flow.
• Lower Your Mortgage Term – If you’ve lowered your interest rate and monthly payments by a significant amount you may be able to afford to decrease the length of your mortgage term. You would do this by paying a little bit more every month and yet paying less than what you were paying originally.
• More Cash in Hand – Refinancing a mortgage means your replacing your current mortgage with a new one. That means you can refinance by taking out a larger mortgage, which would end up freeing up cash for you to use on home renovations and other expenses.
• Choice of Variable of a Fixed Rate – When you refinance you’ll be able to change your rate to a fixed or variable rate. 
• Consolidate Debt –  Refinancing can help free up cash that you can use to consolidate your debts.  This is usually possible when you refinance by taking out a larger loan than your existing one. The difference between the two is the amount of cash you can then use to pay off your debts.

What Are The Cons Of Refinancing Your Mortgage?

• Longer Loan Period – When you refinance a loan, the term usually gets extended. If you refinance a 30-year loan in which there are 25 remaining years with another 30-year loan you are then extending your initial 30-year loan to a 35-year loan.
• You Will be Incurring More Fees by Refinancing. These fees may not be easily recovered through lower interest rates.
• You May End up Taking Out a Bigger Mortgage. By incurring new costs related to the loan and using the loan money to pay for it, the amount of your loan can end up being bigger than it needs to be.

Can You Refinance A Mortgage If You Have Bad Credit?

Mortgage refinancing can help lower your payments and save you money. But is it possible to refinance your mortgage if you have poor credit? The short answer is yes, you can. However, there are a few things you can do to help smooth the process:

Make Sure Your Application Is Attractive

It is very important to understand that refinancing your mortgage with lower-than-average credit can make it difficult to qualify. To help improve your candidacy as an applicant, be sure to include all the necessary documents like pay stubs, the prior year’s tax documents, and any other supporting information you can. 

For example, if you are due for a large raise or promotion, request a letter documenting the change in your pay to show. Job history demonstrates security so asking for a letter from your human resources department documenting the tenure of your employment can also improve your application.

Build The Equity In Your Property

No matter how beautiful your home is, few banks will be willing to refinance your mortgage if you owe more on it than it is worth. Banks issue loans based on the market value of your property and without your own money invested, the investment for a third party is risky. 

Different banks require different amounts of equity so be sure to do your research. For example, more conservative banks may want you to have 25% of the home’s value invested, while more aggressive lenders may be okay with 5% to 10% home equity.

Figure Out Your Break-Even Point

Replacing a 5% interest rate with a 4% rate isn’t as simple as it sounds. There are fees and other costs associated with a mortgage, such as closing costs. This can make it difficult to calculate the savings in interest versus the cost of refinancing. As a rule of thumb, refinance only if you can save yourself at least half a percent on your current interest rate, although more is better.

Consider Government-Insured Loans

Canada, like many other countries, offers government-insured loans. Most government-backed mortgages require less money down and less equity on your home, making it easier for homeowners with poor credit to refinance. 

Additionally, the Canada Mortgage and Housing Corporation has many resources for borrowers and can help you understand what you can afford and whether refinancing is right for you. While there are some caveats and restrictions on government-insured loans, there are also many benefits for borrowers. 

Check out the RRSP Home Buyers’ Plan can help you get a mortgage.

Know What to Expect

When refinancing your mortgage, it’s important that you have realistic expectations especially if your credit is less than great. If you have bad credit and want to refinance your mortgage with the bank holding your original mortgage, you may not be offered the lowest rate on the market. 

For consumers struggling with their credit, working with a mortgage broker who can match you with a great B-lender is probably your best option.

Should You Refinance Your Mortgage?

Overall, do not refinance your mortgage if your home has decreased in value. The refinanced loan will be granted on your property’s current value. Thus, the refinanced loan may hold less value than the initial mortgage loan.  Refinance your mortgage when:

• You’ve built up some equity in your property 
• You have a good payment record
• You want to reduce your monthly payments
• You want to change from an adjustable rate to a fixed rate 

Additional Reading

How To Borrow Using Your Home Equity

Second Mortgage Rates

Mortgage Default Insurance (CMHC Insurance)

Bottom Line 

Refinancing your mortgage can alleviate some of the pressure you may feel from your current mortgage. It can lower your interest rate and payment amount to a certain degree. Depending on your income, you may even be able to pay off your mortgage earlier. However, do remember, refinancing can be tricky and you should keep our tips in mind when considering it. If you are certain refinancing your mortgage is right for you, Loans Canada can help connect you with a third-party mortgage specialist.

Refinancing A Mortgage FAQs

Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.