Refinancing can be defined as the placement of a new mortgage to pay out an existing mortgage while using the same property as collateral. This can be done with the same mortgage lender, or with a different lender. Some of the main reasons for mortgage refinancing are as follows:
Take advantage of lower interest rates
Extend amortization to decrease mortgage payments
Shorten amortization to pay off mortgage faster
Money for investments
Money for renovations
Buy a car, boat or motorcycle
Money for a special occasion such as a wedding
Pay for college tuition
Take a Vacation
Let's take a closer look at each of these reasons for mortgage refinancing to give you a better understanding as towhether mortgage refinancing is right for you.
Take advantage of lower mortgage rates
If you are losing sleep because today's interest rates are quite a bit lower than what you are paying on your mortgage, then it might be time to consider refinancing. You would basically be exchanging a high mortgage rate for a lower one, giving you a lower monthly payment. Today's mortgage rates.
Mortgage refinancing can be a good option if you have other debts that you are paying higher interest rates on. Debt consolidation allows the borrower to consolidate all their debt into a single low interest mortgage loan. Learn more about debt consolidation.
Extend your amortization to decrease mortgage payments
Canadian mortgages can be amortized for up to 35 years (this is the amount of time it will take to have the mortgage paid off factoring in equal payments). In cases where there is 20% equity remaining after the mortgage refinancing, then a 40 year amortization is possible. By extending your amortization, you are extending the length of the loan and therefore, lowering your monthly mortgage payments. For example, a $250,000 mortgage at 5.5% amortized over 20 years will have a monthly payment of $1,369 (rounded to the nearest dollar). By refinancing to a 35 year amortization at the same interest rate, your monthly mortgage payment will drop to $1,066 saving you $303 per month. It is important to remember that by increasing your amortization, you will also be taking on more interest.
Shorten amortization to pay your mortgage off sooner
If paying your mortgage off sooner is one of your goals, then a shorter amortizationis one way of achieving it. Perhaps you went with a longer amortization to qualify or to receive lower payments when you arranged your mortgage, but are now in a better financial position to handle a lower amortization. The lower the amortization the higher the payments will be, but the portion of each payment that is applied to your principal will be far greater. Mortgages are typically amortized in 5 year increments from 5 years to a maximum of 35 years.
Extra money for renovations, investments, purchases or a special occasion
Do you plan on renovating your home, investing money, or purchasing a car or boat? Maybe you have college tuition or a special occasion such as a wedding that you need to pay for. Whatever your reason for needing extra money, refinancing can be a great way to borrow money while taking advantage of your low mortgage rates.
BEFORE MORTGAGE REFINANCING
Before jumping into mortgage refinancing, you want to first make sure that it is going to be worth your while. The first step is to check with your existing lender to find out what penalties are involved in paying out your mortgage early. Once you have established what the penalty is going to be, you can then compare your existing payment with your payment at the new interest rate. Then factor in how much you will save over the term of the new mortgage, and subtract the penalty.
For example, lets say you have a $250,000 mortgage at 6% interest, a monthly payment of $1,600 per month with 48 months remaining on the mortgage term. In this case, we will use a $3,000 penalty for paying out the existing mortgage with the proceeds from a new mortgage at 5% interest for the same amount, but extending the amortization to 35 years giving us a new monthly payment of $1,268. We are including the $3,000 penalty in the new mortgage for this example. This represents a difference of $332 per month. If you multiply the savings by the 48 remaining payments they had on their first mortgage and subtract $1,000 for closing costs, they will have saved $14,936 over this period. If the client in this example needed to cut expenses at this time, this would be well worth it as their savings over the 48 months significantly exceeded the $3,000 penalty. So why not jump right into doing it? This is great if the borrower is in need of more cash flow over this period, but by extending their amortization to 35 years, they will end up paying a substantial amount more in interest. They can always make this up by renewing their mortgage at the end of the term for a lower amortization making up for any extra interest they paid, or by making additional payments toward their mortgage.
MORTGAGE PREPAYMENT PENALTY
Most mortgages in Canada carry a mortgage prepayment penalty for paying it off, or refinancing the mortgage before the end of its term. The mortgage prepayment penalty, is most commonly equivalent to the greater of either three months of interest, or what is called the ‘interest rate differential’, or IRD. The interest rate differential is the difference between your current rate and the rate that the bank can lend money out for today if they were to lend the funds out for the remaining term of the mortgage. It is best to contact your lender to find out exactly how much you will have to pay to get out of your existing mortgage. The penalty amount can end up being much less than you would end up saving
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