When to refinance a mortgage

If you have recently purchased a property, you are likely well aware of how intensive the mortgage application process can be. From gathering documents such as proof of income and credit status to reviewing and signing the mortgage agreement itself, there are a lot of moving parts! Now that you have secured your mortgage and set up your automatic payments, you may think that you can stop worrying about it altogether. But wait – before you put it out of your mind, you’ll want to know all about the mortgage refinancing process. 

What is a mortgage refinance? 

A mortgage refinance essentially means that the homeowner is paying off their existing loan and replacing it with a new mortgage that has different terms. The application process for a refinance is similar to the original mortgage application process, and usually includes calculating your loan to value ratio, credit and income checks, and more. Refinancing a mortgage can cost between 3-6% of a loan’s principal depending on the lender, so it’s important to only refinance if it makes financial sense for you.

Why refinance? 

There are many different reasons why a homeowner would refinance their mortgage with a mortgage broker. Let’s take a look at the most common reasons below: 

• To secure a lower interest rate

  One of the most common reasons that people refinance their mortgage is to take advantage of a lower interest rate than the one attached to their current mortgage. Many experts agree that it is worth refinancing if you can lower your interest rate by at least 2%, but recently many lenders have stated that even a 1% drop is enough incentive.
  
  Not only does reducing your interest rate save you money in interest payments over time, but it also speeds up the rate at which your home equity builds. Home equity is calculated by taking the value of your home and subtracting the remaining pricipal amount. The faster you pay down the principal loan, the faster your equity increases. For example, if your home is worth $100,000 and you currently have a 30 year fixed rate mortgage with a 5.5% interest rate, you are paying $568 monthly in principle and interest payments. When that loan is refinanced to become a 4.1% interest rate, the monthly payments drop to $477. Since you are paying much less interest, you may have the funds to contribute a greater amount towards your principal loan.

• To shorten their mortgage term

  When you initially sign your mortgage agreement, the idea of a 25-30 year term can seem daunting. But what if there was a way to shorten that term? Many homeowners refinance their mortgage in order to do just that without drastically changing their monthly payments.
  
  Here is an example: If you have a 30 year fixed rate mortgage with a 9% interest rate on a home valued at $100,000, your monthly payment is $805. With just a slight increase of the monthly payment to $817, you can refinance at 5.5% interest and cut the term from 30 years to 15 years! That being said, if the same mortgage changed from a 5.5% interest rate and a 30 year term to a 3.5% interest rate a 15 year term, the payments would increase sharply from $568 to $715. This is why each situation is unique, and what could save some homeowners lots of money may actually cost more for others.

• To convert their mortgage type

  Another common reason that homeowners refinance is to change their mortgage from a variable rate mortgage to a fixed rate mortgage or vice versa. While many variable rate mortgages can start off with lower interest rates than their fixed rate counterparts, they can be subject to periodic increases which may lead to a higher interest rate than the currently available fixed rates. If this happens to you, you can refinance your mortgage and switch to the lower fixed rate. This will save you money in interest payments as well as remove any stress about future rate increases. 

On the other hand, converting from a fixed rate mortgage to a variable rate mortgage can also be a smart financial decision if the interest rates are trending downwards and the homeowner does not plan to be in their home for more than a few years. This is because they will see the immediate benefit of a lower monthly interest payment, but won’t have to worry about how high interest rates will be 20 or 30 years down the road.

• To access home equity

  Lastly, some homeowners use a mortgage refinance to access equity in their home – but this should only be done using the up-most caution. It can be financially smart to refinance your mortgage in order to access funds for emergencies, debt consolidation, large renovations, medical expenses, or education, but if you plan to do this be sure that the math adds up. For example, if you were to borrow this money from another source, would the interest payments be higher or lower than through your mortgage? In this case, it usually only makes sense to refinance if you are planning to stay in your home for more than a few years – that way you can recoup the refinancing costs of 3-6% of your principal. If you aren’t 100% sure that this is your best option, research all of your options thoroughly and speak to a financial professional for a second opinion before making any decisions.

Should you refinance?

Now that you know a bit more about how and why you should refinance, you are more informed to make a decision about when is the right time for you to start the refinancing process. When the time is right, refinancing can be a smart financial move that can save you hundreds or even thousands of dollars. Before refinancing, always ask yourself: what are my plans for this home, and how much money am I saving by refinancing my mortgage?

If you would like more information on mortgage refinancing, or would like to know if now is a good time for you to start the process, contact a mortgage broker today.