Homeowners often ask, “What’s involved in refinancing a mortgage and should I do it?” The first part of the question is easier to answer than the second part, which really depends on your financial needs and personal situation.
Essentially, refinancing means breaking your current mortgage and taking out a new one for up to 80 per cent of the appraised value of your home. You might do this for various reasons: to pay down larger debts (credit lines, credit cards, student loans), to invest in a down payment on another property or even to do home renovations that further increase the value of your home.
When people take out a second mortgage, they often have more equity in their home than they once did, so the amount of money they borrow can be substantial compared to the mortgage they are breaking. An increase in equity typically happens because you’ve already paid off some of the principle or because the value of your house has grown due to renovations or an overall rise in the market value of homes in your area.
If you feel a second mortgage would be advantageous, you apply for the refinancing just like a brand new mortgage. That means you’ll be subject to credit checks and you’ll need to submit new employment documents along with your current mortgage statement and property tax documents. You do not have to provide the original down payment documents as they are provided with the appraisal.
Refinancing costs money. That includes the appraisal ($300-$400) as well as any penalties for breaking your mortgage. The penalty depends on the rate type (fixed or variable) and the lender’s method of calculating the penalty, but for a variable rate mortgage you can probably expect the lender to levy a penalty equivalent to three months of interest payments on your existing mortgage. You can call your lender at any time to find out the current penalty.
The lender might charge the penalty upfront, incorporate it into the new mortgage amount or blend it into the rate, slightly increasing the rate you are charged above the lowest offered rate.
There are also lawyer or notary fees, usually between $500 and $1,000, because you would be re-registering your home at a higher valued amount.
Typically, the mortgage rates for a refinance are slightly higher than an insured mortgage because the banks are taking on additional risk.
Refinance plus improvements mortgage
A refinance plus improvements mortgage is a special program to cover the cost of renovations. With this program, you can refinance up to 80 per cent of the increased value of your home. In other words, if your home is worth $150,000 more because of improvements, you could get a mortgage of up to $120,000. Payments on the loan are added to your existing mortgage payments and, because mortgage rates are lower than credit line rates, the renovation loan ends up costing you less.
You would have to pay for the work yourself, but after the project is complete and an appraiser verifies that the work was completed, you would be reimbursed by the lender. Just remember that the lender has to agree on the mortgage before the contractor starts work, even though you don’t actually get the money until the project is finished.
Another option for renovations is a home equity line of credit where you are charged interest only on the amount of money actually used. There would still be legal fees as well as appraisal charges.
Clearly, refinancing a mortgage has many implications. Whether or not you should do it depends on your personal financial situation, and if you’re uncertain you should consider talking it over with your financial advisor.
This article was originally published Aug. 29, 2017. It has been updated to reflect changes in market conditions.