The prospect of owning and financing a home can be terrifying, especially for new buyers or those with poor credit. After all, the financial investment involved in purchasing a home can be expensive. For those already locked into a mortgage that has become a burden, it’s important to understand that “refinance” is not a dirty word. Refinancing your home can be a great way to save money and lower interest payments, even with mediocre or below-average credit. It’s easy to understand the urge to sit idly by, especially since refinancing can be trickier with a blemished credit history but that’s no excuse.
Refinancing your mortgage loan basically means taking out a new loan with different terms to pay off the original mortgage. Basically, this means getting rid of the original mortgage by paying it off with the new loan and then paying off the new loan instead.
By refinancing your loan you’re performing a complete overhaul so you do not need to agree to a loan with similar terms. If you initially went with a fixed-rate you have the absolute freedom of choosing any other type of mortgage loan.
In order to qualify for refinancing you’ll need to meet a couple of requirements. In general, lenders require 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 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.
Lenders may also require you to provide certain documents for verification such as a T4 slip, pay stubs, bank statements, notice of assessment, mortgage statement, or property tax bill.
Before deciding to refinance your mortgage, do make sure to factor in the fees. When you refinance, you’ll have to pay for 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 interest or the interest rate differential (IRD) penalty, whichever is more.
Lower Monthly Payments – Refinanced 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.
As previously mentioned, refinancing is tricky. It can be a really smart move or a move you could regret, depending on the decisions you make. So, it’s important to make good, educated decisions when considering refinancing your loan. Even if your credit is poor, here are five tips to smooth the process.
Make Sure Your Application is Attractive
It is very important to understand that refinancing with lower than average credit can be challenging so it is crucial to get your ducks in a row before you begin. Turning in a lacklustre application with a poor credit score will not improve your petition. This includes making sure you have all necessary documents pulled together, like pay stubs, the prior year’s tax documents, and any other supporting information you can.
For example, if you are due 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. When in doubt, too much supportive information demonstrating why you are a good candidate is better than not enough.
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 you want to refinance your mortgage with the bank that holds your original mortgage, you may not be offered the lowest rate on the market. For those consumers who are struggling with their credit, working with a mortgage broker who can match you with a great B-lender is probably your best option.
Have 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%.
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 the math required to make sure a mortgage is right for you a little trickier. As a rule of thumb, refinance only if you cansave yourself at least half a percent on your current interest rate, although more is better. Finding the right rate might require shopping around, so be prepared to exercise patience in your quest for the best scenario for you.
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. If you feel that your other options are not right for you, this can be a popular choice.
While refinancing, especially with poor credit, can seem overwhelming, it is important to realize that it can save you money over the years. By following the tips outlined above and doing your best to keep yourself financially sound, you can refinance your home and save yourself money and as well as time spent fretting about the state of your mortgage interest rate.
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
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 afford 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.
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
An appraisal involves assessing the value of a property based on current market values and is conducted by an appraiser that is typically assigned by a lender. The appraisal is then used by the lender to determine whether or not to extend a mortgage to a borrower.
A bridge loan is a type of short-term loan that may be used to “bridge” the gap between carrying a mortgage on an existing home and covering the mortgage for a new home. These are usually obtained when the closing dates of a home sale and purchase overlap, requiring the seller to continue paying the mortgage on the existing home before it closes while paying the mortgage on a new home.
Canadian Housing and Mortgage Corporation (CMHC)
A governing body in Canada that oversees and executes several federal housing projects in relation to the National Housing Act.
A cash-back mortgage allows borrowers to obtain the mortgage principal and a percentage of the loan amount in cash, which can come in handy to cover the cost of certain expenses, such as making home improvements or paying for car repairs. Rates on these types of mortgages tend to be higher compared to other home loans.
A closed mortgage allows borrowers to prepay only a certain amount of the principal without being charged a prepayment penalty fee. Fixed-rate closed mortgage prepayment penalties are usually 3-months’ worth of interest or the interest rate differential, whichever of the two is greater.
Before a real estate transaction closes, certain closing costs will need to be paid, which can include real estate commissions, lawyer fees, land transfer taxes, appraisal fees, home inspection fees, adjustments, and others.
A conditional offer is not yet final and means that there are certain conditions that must be fulfilled by the buyer, seller, or both before the sale is considered “firm.” For instance, an offer could be conditional on the home being inspected, which the buyer must be satisfied with.
A construction mortgage allows borrowers to finance the cost of construction of a new home or major renovations.
Your debt ratio determines your ability to pay off a mortgage by measuring your debt relative to your income. Lenders look at debt ratios to assess a borrower’s ability to make mortgage payments. A high debt ratio means your debt load is too high relative to your income. Gross debt service ratio refers to your debt that does not include a mortgage payment, and total debt service ratio refers to your total debt including mortgage payments.
A deed is a document signed by the seller that transfers ownership from the seller to the buyer.
A down payment is the money that is put toward the purchase price of a home. The required down payment will depend on a number of things, such as the type of mortgage being taken out and the cost of the house.
An offer goes “firm” after all conditions have been satisfied and signed off by all parties. A sale can also be immediately firm if no conditions are included.
A fixed-rate mortgage means that the interest rate does not change throughout the entire mortgage term. Even if posted interest rates go up or down during the term, your rate will be locked in and stay the same until the term ends.
Foreclosure is an unfortunate situation in which a homeowner loses possession of the title of their home as a result of mortgage payment defaults. When mortgage payments are missed, the foreclosure process may begin after a certain number of days have passed. In this case, the lender can take over the home under a “power of sale,” after which the homeowner may still have a chance to make good on their mortgage payments and bring their debt up to par. Otherwise, the lender may make efforts to sell the property to recover any money they are owed.
Gross Debt Service Ratio
A gross debt service ratio is the measure of housing-related debt relative to a borrower’s income. GDSR is a factor that lenders consider when determining whether or not to approve a mortgage application.
A high-ratio mortgage refers to a mortgage in which the principal is greater than 80% of the property’s value. That means more than 80% of the home’s value must be borrowed in order to buy a home, while the down payment is less than 20% of the property value. High-ratio mortgages require mortgage default insurance to be paid.
Home Buyers’ Plan (HBP)
The First-Time Home Buyers’ Plan (HBP) is a government incentive program that allows first-time homebuyers to withdraw up to $25,000 from their Registered Retirement Savings Plan (RRSP) – or $50,000 in total for first-time home buyers and their partner – to buy or build a home. The full amount withdrawn must be repaid within 15 years.
The equity in a home represents the value of the property, less total outstanding debt, that the owner actually owns outright. It is calculated by subtracting the total mortgage loan amount still owed by the property’s value.
Home Equity Line of Credit (HELOC)
Using the equity in your home, you can secure a line of credit that uses the equity as collateral. The credit limit is usually equivalent to a particular percentage of your home’s value and there is a set date when the loan must be repaid. If you default on this kind of loan, the lender can repossess your home and sell it to cover the owed debt. Since there is a high risk with this type of financing, it is typically used to finance big purchases such as home improvements, education, or medical expenses.
Many conditions can be inserted into a purchase agreement, including a home inspection. The home inspection allows buyers some time to have the property assessed by a professional to uncover any potential issues with the home before the buyer is obligated to complete the purchase.
Interest is added to the principal amount of the mortgage and is paid to the lender in exchange for access to the funds needed to complete a real estate purchase. Interest is charged from the moment the money is received to the moment the term expires.
Land Transfer Tax
Land transfer taxes are charged by the province in which the property is being purchased, as well as in certain municipalities. It is a type of tax that is based on the purchase price of the property, though these taxes vary by province. First-time homebuyers are sometimes exempt from paying the entire land transfer tax amount and may be eligible for a rebate.
The maturity date is the date when the mortgage term ends. It is at this point that the mortgage must either be paid in full, refinanced, or renewed for a new term.
A mortgage is a loan that is provided by a lender to help a homebuyer complete a home purchase. Lenders provide a certain amount of money required to cover the cost of a home’s purchase price while charging interest on the principal amount. The loan is collateralized by the property itself. The mortgage must be repaid according to the terms of the contract. If the loan amount cannot be repaid according to the terms, the lender has the right to repossess the property and sell it to recoup any losses.
A mortgage broker is a professional who works on behalf of the borrower and finds the best mortgage product and lender among their network of lenders.
Mortgage Default Insurance
Mortgage default insurance is designed to protect the lenders when a borrower is unable or unwilling to repay their mortgage. This is applicable to high-ratio mortgages where the down payment amount is less than 20% of the purchase price of the property and does not apply to conventional mortgages. Borrowers are responsible for this payment.
A mortgage discharge is issued by the lender when the mortgage is paid off in full by the borrower. When the mortgage is fully repaid, it is discharged from the title to the property and certifies that the property is completely free from the mortgage debt
Mortgage Life Insurance
Mortgage life insurance is an optional policy that borrowers may take out. It is designed to reduce or pay off the mortgage amount (up to a certain amount) in the event of the borrower’s death.
A mortgage payment is the regular payment borrowers are required to make to pay off their home loan. These payments can be made monthly, semi-monthly, biweekly, or weekly, and include both principal and interest.
A mortgage pre-approval involves having your credit and finances checked out before you formally apply for a mortgage once you agree to purchase a particular home. It allows you to find out how much can be afforded, how much the lender is willing to lend, and the interest rate that may be charged. Pre-approvals expire within 90 to 120 days after they are issued and are not a guarantee of final mortgage approval.
The mortgage principal represents the amount of money borrowed from a lender and does not include the interest portion.
Lenders typically submit a mortgage statement to borrowers on a yearly basis that details the status of the mortgage, including how much has been paid and the principal on the mortgage that still remains.
The mortgagee is a mortgage lender.
The mortgagor is the borrower.
Multiple Listing Service (MLS)
The Multiple Listing Service (MLS) is a database of listings where real estate professionals market properties they have for sale and search for properties for sale for their clients.
The offer represents the purchase agreement that the buyer submits to the seller and that the seller can either accept, reject, or negotiate with the buyer. The offer includes the offer price, deposit amount, closing date, conditions, and other items pertinent to the transaction.
An open mortgage allows borrowers to repay their loan amount in part or in full without incurring any prepayment penalty fees. Open mortgages tend to have higher interest rates compared to closed mortgages but are more flexible.
The posted rate is the lender’s benchmark advertised interest rate for mortgage products offered. These are not necessarily set in stone, but may be negotiated with the lender.
Prepayment is made when some or all of the loan amount is paid off before the end of the mortgage term. Most open mortgages can be paid off early without any prepayment penalty charges, but prepaying a closed mortgage typically comes with a prepayment charge. However, most closed mortgages allow an annual prepayment of anywhere between 10% to 20% without any penalty.
When all or part of a closed mortgage is paid off before the end of the mortgage term, a prepayment charge may have to be paid to the lender.
The prime rate advertised by a lender is typically based on the Bank of Canada’s interest rate that is set each night, which may change at any time.
Property insurance must be paid on a home throughout the mortgage term. Lenders require a policy to be held on a property before they agree to extend a mortgage, and the lender must be named on the policy. This type of insurance covers the cost of any repair or replacement as a result of damage to the home from fire or other disasters.
Property taxes are paid by homeowners to their respective municipalities to cover the cost of things such as police, garbage collection, policing, schools, and fire protection. The property tax amount paid is based on the property’s value and the rate charged by the municipality.
A qualifying rate is the interest rate that a lender uses to assess a borrower’s eligibility for a mortgage and to calculate your debt-service ratio.
When the term of a mortgage expires, another term may be negotiated with the lender. If the mortgage is not renewed, it must be paid off in full.
Homeowners over the age of 55 can use a reverse mortgage to borrow as much as 50% of the home’s value to be used to pay for other expenses. Payments are not made on a reverse mortgage, but interest can accrue on the loan amount until the property is sold or until the homeowner passes away.
A second mortgage may be taken out on a home that already has a mortgage on it. The funds accessed through a second mortgage from the home’s growing equity may be used to cover other expenses, such as home renovations, but they carry more risk than first mortgages.
Statement of Adjustments
The statement of adjustments outlines the purchase price, deposit, and any financial adjustments that are required for taxes, utilities, or condo fees that have been prepaid by the seller and payable by the buyer to compensate the seller for fees already covered on the home.
A survey is a plan of the property’s lot that shows the lot size and where the property boundaries and building structures lie. It will also show where any easements, right-of-ways, or overhanging structures from adjacent properties that could impact the value of the home.
The mortgage term is the period of time that you are committed to your mortgage with your lender, including the interest rate. When the term expires, the mortgage either needs to be paid off in full, refinanced, or renewed, either with the same lender or a new one. The average term is 5 years, though it can range anywhere from 1 to 10 years.
Title is the ownership provided to a homeowner when a property is purchased. A clear title is required by lenders before a mortgage is extended. If there are any issues with the property’s title, they must be resolved before the transaction closes.
Title insurance is meant to protect lenders and buyers from issues on the title that are discovered after the transaction closes. Title issues can include title fraud, encroachments, municipal work orders, or zoning violations. If title insurance is purchased, it will be added to the closing costs.
Total Debt Service Ratio
The total debt service ratio refers to the percentage of gross annual income needed to cover all debts in addition to the mortgage payments (including principal, interest, taxes, utilities, and more).
With a variable-rate mortgage, the interest rate will fluctuate based on a financial index. Monthly payments could remain the same, but the amount paid toward interest versus principal could change. If rates increase, more money is paid toward interest, but if rates decrease, more money goes toward the principal.
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