Sep 162019
 

One advantage of owning real estate is being able to access the value of the underlying asset for financial gains. The more properties we own, the more equity we can use to buy additional properties. This is why it’s often easier for homeowners to grow their net worths, but harder for renters. One of the best reasons to refinance is to lower the interest rate on your existing mortgage. Historically, many lenders agree that refinancing is a good idea if you can reduce your interest rate by at least 1.00%.

As we know, a mortgage balance gets paid down slowly over time. In the beginning you might have a $300,000 mortgage. But maybe after the first 5 year term is over, your balance is only $250,000. When you go to renew your mortgage you’ll likely have a couple of options. One is to continue paying down the $250,000 balance. Assuming interest rates haven’t changed, your monthly mortgage payments would also be unchanged, because that’s how mortgages are designed. But the other option is to refinance at a higher balance so your total loan amount is increased. By refinancing, you can access up to 80% of your home’s value less any outstanding mortgages. So if the value of your property is now higher than when you bought it, you could potentially borrow more than your initial mortgage amount against your home. 🙂 But your monthly payments would go up in this scenario because you have more debt.

In order to figure out when is a good time to use one method or the other, we need to consider the following factors.

  • How tight is your budget? 
    If you are already struggling to make ends meet, then it’s usually not a good idea to refinance at a higher balance. Just keep to the lowest amount until your income and spending situation improves.
  • Are there any investment opportunities out there?
    If you expect a good return on a potential investment, then it may be worth it to borrow more money against your home. For example, the Canadian Apartment Properties REIT (CAR.UN) has performed somewhat predictably over the years. Its 1-Year, 3-Year, 5-Year, 10-Year, and even 15-Year returns have all averaged over 10% per year. If my mortgage rate is 3% then that’s a 7% gap minimum, before taxes. It’s reasonable to assume that a margin of safety of 7% is a low level of risk, considering the stability of Canadian real estate.
  • Do you have any other debts?
    Using home equity is a great way to pay out higher interest debt through a refinance. For example, let’s say you have outstanding car loans, student loans, and credit card balances that combine to equal $50,000. Chances are these are all charging a higher interest rate than your mortgage. So instead of refinancing at $250,000 you could simply grow your mortgage debt to $300,000. And use the extra $50,000 to pay off your other debts, saving interest expenses over time.

In terms of how to get more equity out of your home, you could either take on a home equity line of credit, or blend and extend your current mortgage with your lender. Please be aware there are costs associated with refinancing. If you want to refinance in the middle of your term to access equity or lower your interest rate your lender will charge you a penalty. For fixed mortgage rates this penalty is the greater of 3 months interest or the interest rate differential payment (IRD). For variable mortgage rates this is simply 3 months interest. There may also be lawyer fees involved with a refinance. You can also have multiple mortgages from different lenders at the same time, but a 2nd or 3rd mortgage will often come with a higher interest rate and may not be worth it. So it’s important to consider which type of refinance you need before renewing your mortgage. 🙂

 

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