Refinancing as a Way to Save Money and Get a Handle on Debt

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Most homebuyers barely think about their mortgage once they've got it: the payment comes out of their bank account automatically, and few people give much thought to the rate or terms their mortgage broker arranged for them.

Of course, every now and then we might wonder whether our rate is any good, but more often than not, it's the broker who reminds us that our mortgage renewal is coming up. That's usually when we actually start thinking seriously about where and how to get the best terms.

But you don't always have to wait for your official mortgage renewal date to roll around. In fact, with interest rates as historically low as they are today, refinancing early can lead to significant monthly savings and help you build a more solid financial cushion - even after accounting for the penalty for changing your mortgage terms ahead of schedule.

There are several reasons that might get you thinking about refinancing. The most common ones include accessing the equity in your home for further investment, cosmetic or major home renovations, and certain life events that change your usual routine. And, naturally, the desire to take advantage of low interest rates.

If you've built up a large balance on credit cards or lines of credit and are finding it hard to keep up with the payments - regardless of how long you've lived in your home, or how long you plan to stay - it's worth considering refinancing. Carrying excessive debt while owning a home can lead to missed payments and/or a damaged credit score, putting your financial future at risk.

According to Statistics Canada, the debt-to-income ratio (the most common measure of debt burden) averaged 165.3% in the first quarter of 2016. In other words, consumers owed more than $1.65 for every dollar of disposable annual income - a fairly alarming figure!

Still, if you own property, there's light at the end of the debt tunnel. Homeowners can pull equity out of their home through a cash-out refinance. With this type of refinancing, your existing mortgage is replaced with a new, larger one, and you receive the difference in cash, up to 80% of your property's value. In effect, you're accessing the equity in your home by borrowing against the portion of your mortgage you've already paid down. This can be an excellent strategy for paying down expensive debt, since this method often comes with a lower interest rate as well.

The same principle applies to financing renovations or major life events, such as your children's education. Since your home is likely your most significant asset, renovations and improvements can meaningfully increase its value. The same goes for investing in education. Either way, run the numbers carefully ahead of time and stick to a set budget.

If you've decided to refinance for whatever reason, make sure you're properly prepared for it. Start by finding out the exact current balance on your existing mortgage, then compare your home to recent sales in your neighbourhood by consulting with your Realtor, and use that data as a general indicator of your home's value - if your equity comes to less than 20% of your home's value, refinancing likely isn't your best option right now.

Next, check your credit score with Equifax or TransUnion. The better it is, the better a rate you can get. That doesn't mean you can't refinance with a poor credit score; it's still possible even then. But you'll need to figure out what rate you can actually get given your numbers, along with all the costs associated with closing the deal. Only then will you know whether refinancing genuinely makes sense for you.

It's also worth understanding that refinancing is treated the same as applying for a brand-new loan, so you'll need to have all your paperwork ready. That includes your mortgage application, your most recent property tax assessment from your city, a letter from your employer, a statement of income, and likely your tax returns from the Canada Revenue Agency (CRA) for the past 2 years.

All of this makes clear that no two mortgages are exactly alike. How much you can save through refinancing depends on which components of your existing mortgage are flexible, and which aren't.

Penalties are a perfect example. Their terms are often written in fine print, and no one goes out of their way to draw your attention to them, but don't let them ruin your plans. Ask your mortgage broker or your bank for the exact penalty amount. Breaking your contract to secure a lower interest rate can save you a lot of money down the road, and depending on the penalty, the remaining mortgage balance, and/or your outstanding debt, it may well be worth it.

If you have a variable-rate mortgage, expect to pay a penalty equal to three months' interest. With a fixed-rate mortgage, you may end up paying more: either three months' interest, or the interest rate differential, whichever is higher. The latter is the difference between your original rate and the rate the bank is charging today. The calculations can get fairly complicated, and most banks use their own particular methods for working it out. To find out exactly what breaking your mortgage contract will cost you, get in touch with your broker or reach out to your financial institution directly. The key thing here is to think long-term and talk to a mortgage professional about all your options while interest rates remain this low and property values sit at record highs. And it doesn't matter how soon your official renewal date is! If you're planning to stay in your home for a long time to come, refinancing could be an excellent choice for you. It may involve some changes along the way (and the whole process may seem like it'll take a lot of time and effort), but it can hand you much greater financial freedom down the road, along with a little less day-to-day stress about your finances. And don't forget, you can also use refinancing to raise funds for buying a new investment or rental property.