Most people choose a five-year term for their mortgage. When a term is up for renewal, mortgage holders can renew their mortgage for anther five-year term or choose from another option offered by their lender. More and more people are actually taking this opportunity to shop for a mortgage more suited to their needs at renewal. This can be for many reasons including a better rate, better portability options, and better flexibility with prepayment.
A renewal usually requires that the terms of the mortgage including amount owed and amortization to remain the same. Any increase to the amount or increase to the amortization would usually require a refinance. Some lenders may be able to extend the amortization of the mortgage without needing to do a refinance.
Depending on whether the mortgage is registered as collateral or not, a refinance may be the only way to move an existing mortgage to a new lender. A refinance at renewal time is ideal as there would be no penalty to break your mortgage and you would only pay one set of legal fees to take out equity and move over your new mortgage. However, sometimes the timing may not be right to refinance at renewal – or the option may never be presented, if the borrower just signs the renewal offer sent by their lender.
People can refinance their mortgage for many reasons, to consolidate debt, to buy out an existing partner after a separation or a divorce, or simply to take advantage of lower mortgage rates. Of course, when refinancing mid-term, pre-payment penalties have to be taken into account and you have to run the numbers to see if it makes sense.
Qualification plays a big role in refinancing. Your current income and debt level has to be in line in order for the lender to accept loaning you a larger amount. With a variable mortgage, you will have to qualify using the five-year benchmark posted rate. Using this higher rate, you would qualify for a smaller amount – so if maximizing the equity take out of your home is important, a fixed rate may be the only option available to you.
Lower Rates vs. Pre-Payment Penalties
If your reason to refinance is just to take advantage of a lower rate, then you have to look at your penalties and add up all the costs. If you currently have a variable mortgage, you would not need to refinance in order to take advantage of lower interest rates as your rate automatically fluctuates with the Bank of Canada’s prime rate. However, if the discount off prime that you have is considerably lower than what is currently available, you would have to see if the three months’ interest penalty will outweigh the overall savings.
If you are in fixed mortgage, then an IRD calculation will determine your prepayment penalty. The calculation must always be done to see if it is profitable to make the switch. Usually, in my previous experience, the payment of the IRD especially with major banks only makes sense either if you have a long time left on your mortgage or if you are consolidating debt, and taking out additional equity.
There is no right or wrong answer to see if refinancing makes sense for you. Work with your broker and run the numbers to see what makes the most financial sense with your overall financial goals in mind. Like I always say, the rate is only part of the equation.