How Does a Cash-Out Refinance Work in Canada? (2023)
Refinancing your home is a big deal, but it could be your next best financial decision! Shifting home equity to avoid sky-high interest rates can leave you with more money in your pocket in the long run.
53% of the cash from refinancing was spent to benefit the long-term financial health of Canadian homeowners. With the right intentions, it can be viewed as “good” debt if used to pay off credit card balances or improve your property value.
With you in mind, we have crafted this guide so you can see if cash-out refinancing can help propel your finances forward.
What is a cash-out refinance?
Cash-out refinancing allows you to use your home equity to help fund bigger expenses such as debt consolidation, wedding planning or home renovations. It replaces your existing mortgage with a higher borrowed amount than what you owe, giving you the difference in cash to use as you see fit.
Wondering how it works? Let's give an example.
Your current home is feeling pretty outdated, and you’d like to renovate after hearing that your friend’s property value went up significantly after their improvements. You’ve decided to start looking into this more seriously, and while you’ve been planning, you realized it’s a lot more expensive than you initially thought. You don’t have access to much cash to make the improvements, but your friend told you that they borrowed up to 80% of their home’s value with cash-out refinancing, which you think could help you too.
You currently owe $250,000 on your mortgage. You have decided to move forward with cash-out refinancing yourself for a total of $300,000, giving you access to $50,000 cash for your renovation and with a lower interest rate than a personal loan.
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How does cash-out refinancing work?
Put simply, cash-out refinancing works by replacing your current loan balance with a new loan for a higher amount. You get access to the monetary difference in cash.
The amount you can borrow will vary, depending on your situation. If you are in good financial standing, you should be able to borrow up to 80% of your home’s value.
Lenders will look at your financial health to decide what amount you qualify for:
- A current home appraisal
- Your home’s equity
- That you’re in good financial standing
Cash-out refinancing rates are generally lower interest than short-term loans or personal lines of credit but with slightly higher rates than your mortgage. You can tap into this money for any number of things. Popular choices include home remodelling to increase your property value or debt consolidation if you pay off high-interest credit cards or personal loans.
Good to know
Have you noticed a spike in housing prices for your neighbourhood since you took out your mortgage? If so, your home may be worth more than when you purchased it, increasing the amount you can borrow.
How can you use a cash-out refinance loan?
Ultimately, you can spend the money from the cash-out refinance loan however you choose. Most Canadians use the funds in a way that either will help them make money, or help them save money from higher interest rates. It’s always a good idea to consider if what you want to purchase is a need or a want.
Most commonly, people spend their cash-out refinancing funds on:
- Renovations that improve the re-sell value of their home or make it more energy efficient for lower monthly utility bills
- Debt Consolidation that saves them high-interest credit cards or personal loans
- Low-risk Investments such as purchasing another property or secure portfolio with stocks, EFTs or Mutual Funds
- Vehicle purchases that would have been financed with higher interest rates through the dealership
What is a limited cash-out refinance?
Are you thinking about refinancing because the market’s rates or terms are better? If you aren’t looking for the cash and don’t want to increase your loan significantly, a limited cash-out refinance could be more suited to you.
Limited cash-out refinancing works similarly to regular cash-out refinancing but with stricter parameters on how much you can borrow along with how you spend it. Its primary purpose is to obtain better rates or terms on your mortgage.
You can only receive a cash amount of 2% or less of the new loan balance, whereas regular cash-out refinancing doesn’t have these same restrictions.
There are costs to factor into limited cashout refinancing, these could include appraisal and legal fees, closing costs or property taxes. In most cases, these can be conveniently rolled into your payment installments which is an added benefit to consider when exploring what option is right for you.
How to do a cash-out refinance?
The process of doing a cash-out refinance is similar to that of a regular mortgage but will depend on the lender you use.
Typically, you can expect something comparable to:
- Shopping around for the best rates and lender for you, you can use a cash-out refinance calculator to help with this
- Review and gather the supporting information and documents you need for your chosen lender, this will most likely be income statements, tax documents, or statements of assets
- Complete the application for your chosen lender
- Have your home appraised in support of your application
- Have a meeting with the approval or denial of your application
- If approved, you will sign the documents & receive the cash-out funds
What are the benefits of a cash-out refinance loan?
Depending on your situation, cash-out refinancing may have one or more attractive benefits. We have compiled the most common here for you:
- Access Cash when you need it: Whether it is for an essential purchase like a vehicle, an important home improvement, or even to pay for a wedding, you have access to use your home’s equity at a low rate.
- Take advantage of better industry rates and terms: The market may have changed since you originally took on your mortgage, and for the better. You can take advantage of better terms and rates with options like limited cash-out refinancing if you don’t need access to much cash.
- Pay less interest: If you have other debts, such as credit cards or personal loans, you can save on interest fees by consolidating them into one loan.
- Benefit from your “good debt”: Benefit from increased property value by funding a home renovation or investing funds into secure, low-risk securities.
- Improve your credit score: You have the potential to increase your credit score by consolidating any debts into only one loan at a lower monthly fee that frees up your monthly cash flow.
Drawbacks to cash-out refinance?
Unfortunately, nothing is perfect and there are downsides to cash-out refinancing to be aware of before jumping in with two feet:
- It still needs to be paid back: You will want to be confident that you can still comfortably pay back your loan, ensuring there is no risk of foreclosure on your home.
- Re-payment can take years: You will be paying off your cash refinance loan for 30 years (most commonly), so if you feel you can pay your credit or other debt off in full sooner, it may be in your best interest to keep the higher-interest options on a shorter term.
- It’s not a low-risk option for things you want but can’t afford: You’re financing cash against your home equity, so you’ll want to ensure you’re making the best financially responsible decision, specifically avoiding non-essential items beyond your means.
- You need to shop around: You’ll be borrowing a larger sum with higher interest than a standard mortgage, so shop around for the best option.
- It’s a few hoops to jump through: From getting all your documents together, going to bank appointments, and waiting for your approval from the underwriter, it takes time and organization before you can access the benefits.
How much can you borrow when doing a cash-out refinance?
To start, you will need to have an appraisal on your home because cash-out refinancing is based on the current value of your house. You will then be able to borrow up to 80% of the value It’s advisable to limit borrowing to the minimum you need, ensuring easier payback and limiting the risk of foreclosure.
There are several resources you can use that will help ensure you get the best rates on the market. You can get a good sense of how much you can borrow by taking your home equity (the worth of your home - the amount remaining on your loan) and finding out how much 80% is. By subtracting your current mortgage from that balance, you can estimate the maximum amount of cash you would have access to.
As an example:
Your home has been appraised for $400,000, and you only have $150,000 remaining to pay off; your home equity amounts to $250,000. You can take out 80% of your home equity, which is $200,000. You still will owe the $150,000 from your original mortgage, making the difference (your cash amount) $50,000.
One thing to keep in mind is that you need to factor in your closing fees which are between 2-6% and likely similar to your first mortgage.
Want to see how much you can qualify for with a cash-out refinance?
Get a mortgage refinance quote today!
Cash-out refinance vs HELOC?
If you’re shopping around and trying to choose which is better, a HELOC or cash-out financing, we can help.
The main difference between HELOCs and cash-out refinance is the rates and how you access your home equity.
A HELOC (Home Equity Line of Credit) lets you tap into up to 80% of your home equity like a credit card, giving you the flexibility to borrow and pay it back at your leisure, but with higher interest rates. It can be a convenient option, but you will need to have a good level of financial responsibility and manage your interest rates to maintain your financial health.
With cash-out refinancing, you will only have access to the cash at the time of closing, and in the full amount. There is less flexibility regarding cash accessibility when compared with a HELOC, but you benefit from having a set repayment structure at a lower interest, paired with less temptation to use your home equity as a piggy bank.
Cash-out refinance vs a second mortgage?
Much like cash-out refinancing, a second mortgage (also known as a home equity loan) allows you to access a lump sum of cash to use the way you see fit using your home as collateral.
You would pay this back monthly as a secondary payment to your existing mortgage payments.
With second mortgages, it is common to see smaller closing costs with a guaranteed interest rate that is still lower than a personal line of credit or regular credit card. Unlike cash-out refinancing, you won’t get new terms or conditions on your mortgage. This may not bother you if you’re happy with your current setup and just looking to access cash using your home equity.
How long does cash-out refinance take?
The timeline for cash-out refinancing will vary from lender to lender and on the complexity of your financial situation. Generally, it ranges from 45 to 60 days from start to finish, like a traditional mortgage.
Below are some aspects that could affect how quickly the cash-out refinance is processed:
- Shopping around for the best lender, terms and rates for you
- Appointment availability with your lender can be challenging since cash-out refinancing has become quite popular
- How quickly you can have the appraisal on your home done
- The state of your financial health and documents when provided to the underwriter for approval
If this is your main home, you will have 3 days (known as a rescission period) after the closing date before you would receive the cash from your loan, this also gives you the opportunity to change your mind - just in case you had a change of heart.
Do you pay taxes on a cash-out refinance?
In Canada, you wouldn’t have to pay income tax on the funds you receive from a loan, so you won’t have to worry about being dinged by the CRA.
In fact, you may actually be eligible for tax deductions if you have decided to use the money for specific home renovations known to add property value such as addition, energy-efficient windows or even a swimming pool!
Get a mortgage refinance quote today!