How does mortgage refinancing work?

James Rodriguez James Rodriguez  updated on 2022-02-28

During the COVID-19 pandemic, mortgage rates fell to record lows, making it an ideal time to refinance a mortgage. The Bank of Canada expects interest rates will stay low through 2022. That is good news for homeowners because ideal conditions for refinancing a mortgage will continue. 

Does that mean you should rush out to refinance and free up equity on your home? Not so fast, because while refinancing your mortgage can be a good move, you need to be sure that it is the best decision for you. How do you know when it is best to refinance a home or not?

Well, the following article is here to help, providing you with all the necessary information for a remortgage - how they work, the pros and cons, when you can refinance and much more.

What is refinancing a mortgage?

It is important to know what refinancing a mortgage means. When you choose to refinance your mortgage, you are essentially breaking your current mortgage loan contract and securing another mortgage loan in its place. Importantly, the new loan is a separate contract with its own interest rate and conditions. 

Taking out a new mortgage on a home is a financial tool that allows you to free up equity or reduce your mortgage payments. Depending on your specific circumstances, you can refinance a mortgage up to 80% of the value of your property. 

There are numerous reasons why refinancing your home may be a sound investment. For example, if you want to make changes to your mortgage terms, refinancing the contract is a relatively hassle-free way to do it. 

How does mortgage refinancing work?

In Canada, the process of refinancing a mortgage is simple and you can choose this option once some equity has been built on your property. Importantly, your current mortgage does not need to be up for renewal before you can refinance the loan. Reasons to consider a remortgage include:

  • Borrow more money against your home.
  • To get a better mortgage rate. 
  • Change the mortgage term length. 

Refinancing a mortgage is a popular borrowing method for millions of Canadians. You can get a large loan lump sum against the equity of your home and often get better interest rates than other types of debt. 

If you embark on the refinancing mortgage process, choosing the best rate and terms is important. Shopping around online for the top remortgage rates is the most efficient way to get the best refinancing conditions that meet your needs. 

If your property has a value of $400,000 and you have previously paid $280,000 on your current mortgage, you could borrow up to $320,000 (80% of the value) and have a $40,000 lump sum.

What are the benefits of refinancing a mortgage?

Refinancing a mortgage is a major financial step where you will be taking on a substantial amount of debt. Like all such financial decisions, there are advantages and disadvantages involved. Let us take a look at some of the pros and cons of mortgage refinance:

Mortgage refinancing pros

  • You can get a better mortgage interest rate and save money on future repayments.
  • Consolidate your debts at a favourable rate.
  • Swap your mortgage types (between variable and fixed term).
  • Access equity to receive a larger lump sum loan than other types of debt. 
  • Change the term length of your mortgage.

Mortgage refinancing cons

  • Debt consolidation can sometimes remove the desire to reduce it quickly.
  • Taking equity involves a large amount of debt. 
  • Penalties could offset the savings you make. 
  • There are typically fees attached to refinancing.

Should I refinance my mortgage?

That is the million dollar question and it depends on your circumstances. Mortgage refinancing becomes a desirable option if you can get a lower interest rate and still make savings once penalty fees are paid. Refinancing is also a solid option if you want to borrow a significant amount of debt because you can borrow against your home equity. 

However, weighing up the potential costs of a mortgage refinance against the potential savings is essential. Most banks charge a break penalty, which is a fee you must pay for ending the original mortgage contract early. The best way to check if refinancing will bring you savings is to use a mortgage refinance calculator. 

Banks often charge a break penalty, so make sure you will come out ahead before refinancing.

How do I refinance my mortgage?

The process for taking out a new mortgage on your home is easy in Canada and involves some simple steps. Here is how to refinance your mortgage:

  • Use an online comparison tool to compare lenders and find the best rates.
  • Research the documentation each lender asks for (such as tax documents, proof of income, etc.)
  • Gather the documentation and organize your applications.
  • Submit your application.

While getting approved can be exciting, we advise taking the time to carefully read the terms and conditions of the mortgage contract. Ensure you cover all the bases, including fees, payment details, the interest rate and contract length. This is where using a mortgage broker can be a huge help, giving you professional support to make the best decisions.

How long does it take to refinance a mortgage in Canada?

Refinancing a mortgage typically takes between two and four weeks.

There is, however, no single answer to how long it can take. Some alternative lenders can be quite quick. The process can sometimes take longer, and the exact timeframe depends on potential obstacles. For example, how long it takes to organize and complete the appraisal, whether your documents are all in order, and other factors. 

Want to know more about mortgages? See HelloSafe's complete guide to mortgages.

When can you refinance a mortgage?

Refinancing at the end of the mortgage term is best because you will avoid paying heavy penalty fees for breaking the contract. Still, many Canadians choose a mid-term mortgage refinance, which can work under the correct conditions. You’ll need to ensure that the savings you make outweigh the fees and costs associated with breaking the mortgage mid-term. 

How soon can you refinance a mortgage?

In legal terms, you can refinance a loan whenever you want, although if you want to use the same lender you will have to wait six months. While there are no legal obstacles, there are some practical ones if you are looking for the best time when to refinance a mortgage. 

You are unlikely to find a better rate if you remortgage within months of the original contract, while you will also have no equity to gain on your home.

What are the best mortgage refinancing rates?

Finding the best rates is a fundamental part of refinancing a mortgage. For many homeowners, the whole point of a remortgage is to get the best interest rate possible. Refinance mortgage rates are higher on average than standard new home mortgages or renewals. The simple reason is that lenders assume more risk by lending you more money. 

Even if you are not borrowing more money, you will be getting a favourable interest rate. Lenders try to offset this with a slightly worse mortgage rate for refinancing. Even so, the rate will be better than you get with other types of debt such as credit cards or personal loans. 

Needless to say, it is essential to get the best mortgage refinancing rates if you want to get the most savings. Compare mortgage refinance rates now from the top lenders across Canada. 

How to refinance your mortgage with bad credit?

Canada has several lenders that specialize in working with borrowers with lower credit scores.

There are many reasons why someone may find themselves with a poor credit score, and lenders are increasingly offering support. Sure, you will not be getting the market-best interest rates, but there are ways to refinance a mortgage with bad credit.

If your credit score is under 600, major banks and lenders will not approve you for a mortgage refinance. Instead, you will need to choose an alternative lender, which will mean you need to make some compromises. For example, the interest rate will be worse, and you may get higher fees and penalties too. 

Is there a penalty for refinancing a mortgage?

Lenders often attach fees for refinancing a mortgage, but it depends on when you want to refinance. If you choose the end of your current mortgage term, you can avoid penalties for breaking the contract. However, ending the loan mid-term does carry penalties that will be the biggest cost of the refinancing process. 

The total cost of the penalty varies depending on the mortgage type, the rate, whether it is fixed or variable, the loan length, and other factors. Mortgage penalties are usually thousands of dollars but can sometimes run into tens of thousands of dollars. That is why it is essential to carefully weigh up the savings you will make before choosing to refinance your mortgage. 

You will also pay legal fees when refinancing a mortgage in Canada. This will cover a real estate lawyer who ensures all the paperwork is legal and in order. 

Refinancing before your mortgage term up usually means paying penalties.

How to lower mortgage payment without refinancing

While refinancing can give you a lump sum loan, most Canadian homeowners choose to refinance to get better mortgage terms. However, there are some steps you can take to reduce your mortgage payments without needing to refinance:

  • Make an extra payment each year: If you can afford it, pay an extra monthly payment each year. While it seems small, you will actually reduce your mortgage term by years over the length of the contract. 
  • Rounding up: Another way to reduce the length of your payment term is to round up each repayment. So, if you pay $1,025 each month, round it up to $1,100. 
  • Loan modification: Speak to your lender about changing the terms of your existing loan. This is especially important if you are having trouble meeting your repayments. 

Refinancing vs. HELOC (Home Equity Loan)

A home equity line of credit (HELOC) is an alternative to a mortgage refinance that lets you to access cash when you need it. To set up a HELOC, you must take out a second mortgage on your home. It is a good way to have a steady stream of credit when you need it, and you pay no interest on the cash until you withdraw it. 

While this is a good choice if you want that steady drip of cash available to you, a HELOC will normally have variable rates that are worse than mortgage refinance rates. You will also not be getting a better mortgage rate and will need to give up having just one mortgage loan. Refinancing a mortgage is also a better option if you want access to a larger lump sum at once.

Want to know more about mortgages? See HelloSafe's complete guide to mortgages.

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