A mortgage refinance gives homeowners the ability to lower their interest rate, change other terms of their loan, consolidate debt or turn their home equity into cash.

Read on to learn how refinancing works, the requirements and costs involved, the pros and cons of refinancing and how to get started.

What Is Refinancing A Mortgage?

Mortgage refinancing is the process of breaking your existing mortgage and replacing it with a new home loan that has different terms.

It’s important to understand that breaking your mortgage early will result in a financial penalty. When deciding whether a refinance is right for you, you’ll want to weigh the benefits and costs against your goals in refinancing.

Why Do People Refinance Their Mortgage?

Generally speaking, there are a few primary reasons to refinance a mortgage.

Secure A Lower Interest Rate

If mortgage interest rates have come down since you signed your existing loan, you could save a significant amount of money by refinancing at a lower rate.

To determine whether this refinance option makes sense for your situation, you’ll need to make sure your potential savings are greater than the cost of the prepayment penalty for breaking your mortgage.

Make Other Changes To Your Mortgage

In addition to helping you secure a potentially lower interest rate, a refinance may also be used to replace your product type, rate or extend your amortization to free up cash flow.

Turn Home Equity Into Cash

With a cash-out refinance, or equity take-out refinance, homeowners who have greater than 20% equity in their home can replace their existing mortgage with a new loan of a greater amount. The difference is then given to them as a lump sum.

That cash can be used to consolidate high-interest debt, pay for home improvements, buy an investment property and more.

Refinancing Requirements

Lenders have certain requirements you have to meet to refinance your mortgage.

Home Equity

Your home equity is the difference between your current mortgage balance and the value of your home. For instance, if your home is worth $400,000 and you have $200,000 remaining on your loan, you have 50% equity. Most lenders require you to have more than 20% equity to refinance. As part of your application process, they will have an appraisal of your home to confirm its value.

Credit Score 

Generally, most lenders require a credit score of 500 – 650 to refinance a mortgage. However, the specific score you’ll need will depend on a few factors. Your lender, loan type and property can all impact your credit score requirements. If you’re taking cash out, you may need a higher credit score to access higher amounts of equity.

Debt Service Ratio (DSR)

The debt service ratio (DSR) is the percentage of your gross monthly income required to pay your recurring monthly debts. 

Your DSR is actually made up of two different figures. The first is your gross debt servicing (GDS) ratio, which measures how much of your gross income goes toward housing costs. The second figure is your total debt servicing (TDS) ratio, which measures how much of your gross income goes toward all of your recurring monthly debts – including housing costs, car payments, student loans, and credit cards.

Lenders will review your GDS and TDS as part of a refinance application to determine your ability to repay your new mortgage. To qualify for a refinance, you generally need a GDS and TDS below 50%.

Financial History

Your financial history and overall financial health play a large part in refinancing, so you’ll be required to provide a few different documents for your refinance application to be considered.

Proof Of Income

You’ll need to provide documents that show proof of your income, such as current pay stubs and T4 slips. The lender will want to see how much money you have coming in on a regular basis and what portion of your pay goes toward your current mortgage costs.

Homeowners Insurance

As with your original mortgage, your lender will require you to have homeowners insurance to mitigate their investment risk in your refinanced mortgage.

Assets

Be prepared to provide documentation on the assets that you have. Chequing, savings and retirement accounts are prime examples.

The Costs Of A Mortgage Refinance

Many of the costs to refinance come in the form of penalties or fees. Let’s have a look at these individually to give you a sense of which you might need to pay and how much you’re likely to owe for each.

Mortgage Prepayment Penalty

If you refinance before the end of your mortgage term, you’ll be required to pay a mortgage prepayment penalty. You can avoid this fee by refinancing when your mortgage is up for renewal, and it will typically be lower if you choose to refinance towards the end of your term than earlier on.

The prepayment penalty will vary depending on the mortgage type. For variable-rate mortgages, this figure is usually equivalent to 3 months of interest. If you have a fixed-rate mortgage, you’ll pay the interest rate differential (IRD) instead, if that figure is greater than 3 months of interest.

Mortgage Discharge Fees

As part of closing out your current mortgage, you’ll be required to pay a fee to discharge the loan. This fee will vary depending on which province you live in and your lender, but you can expect to pay at least $300. If you’re refinancing with your current lender, you may be able to avoid this fee completely.

Mortgage Registration Fee

Whether you’re leaving your current lender or staying, you’ll have to pay a mortgage registration fee that covers your lender removing the current mortgage from the property’s title and re-registering it with the new amount. This fee is determined by the province you live in but is likely going to set you back around $70.

When you go through the refinance process, you’ll need to work with an experienced real estate lawyer. Their services will likely cost you about $1,200 or more, depending on the complexity of the transaction. They can help with everything from conducting a title search and ensuring no liens are on the property to registering the mortgage and reviewing the terms and conditions of the refinance.

Pros And Cons Of Refinancing A Mortgage

Refinancing can be a powerful tool for qualified homeowners, but it also comes with risks and expenses. Let’s have a look at some of the pros and cons of a mortgage refinance.

Pros of Refinancing

There are several benefits to refinancing a mortgage:

  • Potential to lower your interest rate: Taking advantage of lower mortgage rates could help you save a significant amount of money (in interest) in the long run. Just make sure that your potential savings would be greater than the fees associated with refinancing.
  • A new mortgage or different payment length: Some homeowners may benefit from changing their mortgage type, or by extending their amortization period.
  • Access to home equity: A cash-out refinance offers the financial flexibility of converting home equity into cash – and using those funds to pay for home improvements, consolidate debt or make investments.

Cons of Refinancing

As with most life decisions, refinancing comes with its potential drawbacks. Here are a few:

  • Penalties and fees: As discussed, the overall costs of refinancing will depend on a variety of factors. Individual homeowners will have to decide for themselves whether the potential rewards of refinancing will justify the costs.
  • More time paying off your mortgage: For some homeowners, having more time to pay off a mortgage can be a good thing. But if you lengthen your amortization period or convert home equity into cash, you effectively increase the amount of time it will take to own your home outright. This may also result in more interest paid over time.
  • Temporary reduction in credit score: Because lenders will perform a hard inquiry into your credit, you may see a temporary dip in your score when applying to refinance. In many cases, your credit score will rebound or even improve in the longer term. However, you may have a harder time qualifying or getting favourable terms for other loans you apply for while your credit score is recovering.

How To Refinance A Mortgage

In many ways, refinancing is similar to the process of securing a mortgage. Here are the basic steps to getting a refinance.

1. Assess Your Financial Situation

Before you decide to refinance, it’s crucial to consider your financial readiness. You’ll want to examine your credit score, DSR, annual income and other aspects of your finances. This will help you to gauge your readiness as an applicant, as well as your comfort level in proceeding.

At this stage, it’s also a good idea to get a rough estimate of how much your home is worth and how much you owe on your current mortgage.

2. Explore Your Options And Choose A Lender

As discussed, there are multiple reasons to refinance, so you’ll want to decide which approach is best for achieving your goals. 

Once you’ve settled on the type of refinance, you’ll need to choose between refinancing with your current lender and switching lenders. It’s important to note that switching lenders may open you up to additional fees, so make sure the switch is worth it.

3. Apply For Approval

The application process for a refinance will be similar to the original mortgage application process. Your lender will look into your finances and request supporting documentation related to your income, credit score and other debts.

This is the time to review the terms of your new mortgage and ask your lender any other questions you have.

4. Get An Appraisal And A Mortgage Stress Test

As with other real estate transactions, an appraisal may be required to assess your home’s value in the current market. For a cash-out refinance, an appraisal helps to determine how much equity you have in your home, and subsequently how much cash you can take out.

You’ll also be asked to complete a mortgage stress test. Lenders use stress tests to gauge whether you’ll be able to keep up with your new mortgage payments in the event of an interest rate increase.

5. Close On Your New Mortgage

Once your application is approved, you’re ready to close on your new mortgage. This will involve paying closing fees and signing paperwork.

If you’re doing a cash-out refinance, the final step will be to receive your funds.

Refinance Mortgage FAQs

Have more questions about refinancing your mortgage? Review these frequently asked questions.

Is there an ideal time to refinance my mortgage?

The right time to refinance depends on your specific situation, goals and financial needs. Conventionally, the best time to refinance a mortgage is when you are at the end of your current mortgage loan agreement term. This way, you avoid incurring any prepayment penalty fees for breaking your mortgage early. 

Other ideal times include tapping into equity to invest in your home, taking advantage of lower rates or consolidating debt. 

Reach out to a registered mortgage expert to assess whether now is the right time to refinance. 

How many times can I refinance a mortgage?

There’s no limit to the number of times you can refinance your mortgage. However, refinancing may come with penalties or fees. And, If the interest rate on your new loan is higher than the one it replaces, your monthly mortgage payment could go up.

It may be more helpful to consider how many times a mortgage refinance makes sense for your financial situation, rather than the number of times it’s theoretically possible.

Can a mortgage refinance affect my credit score?

Yes, refinancing can affect your credit score – sometimes unfavourably. When reviewing your application, the lender will make a hard inquiry on your credit report. This can lower your credit score, but only temporarily.

If your application is approved, a new mortgage will replace the old one. This may shorten the length of your credit history, which is one important factor in your credit score.

That said, if you’re using a cash-out refinance to consolidate and pay off high-interest debts, refinancing may help to improve your credit score in the long run.

The Bottom Line

Refinancing your mortgage can give you the opportunity to lower your interest rate, access equity or change your loan terms and amortization schedule. However, it’s important to understand the associated costs that come with refinancing. Carefully review the pros and cons and create a realistic budget to see if this option makes sense for you. If you’re ready to refinance your mortgage, start the approval process online today.