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Mortgage refinancing: How it works and its advantages

October 16 2019 by Multi-Prêts Hypothèques
What you'll learn
  • Using your home as a financing tool
  • How does mortgage refinancing work?
  • The home equity line of credit (HELOC)
  • Are you eligible for refinancing?

Are you familiar with mortgage refinancing? Wondering if it's the right option to fund your projects or consolidate your debts? To help you out, here's an overview of how it works and its advantages.

A crazy idea? Not necessarily. If you've owned a property for several years and have a whole list of projects you want to do, your mortgage could help you make them a reality! Mortgage refinancing is a solution that, if used wisely, can help you live life to the fullest.

You're probably wondering how a mortgage can be turned into an investment. The idea behind this strategy lies in the principle of leverage. A mechanical lever uses movement and speed to maximize the effort required to lift a heavy weight; a financial lever works in a similar way when you borrow money to improve your financial situation.
Financial institutions will allow you to use an amount corresponding to a portion of the "net value" or "equity" of your home, which is the difference between 80% of the current value of your home and the balance owing on your mortgage, to invest in your projects. For instance, you can use this option with your primary residence (using its net value) to finance a down payment or even an outright purchase of a secondary residence, like a cottage.

How does mortgage refinancing work?

Refinancing your mortgage simply means re-borrowing a part of the value of your home and the payments you have already made on your mortgage, up to 80% of the value of your home (the maximum amount of the loan). Your financial institution may allow you to borrow less, however, depending on your financial situation.

The current market value of your home:  $400,000
80% of this amount:    $320,000
The amount you still owe on your mortgage:     $150,000
Available equity:     $170,000

 

The home equity line of credit (HELOC)

Speak to a mortgage broker to discuss which products are best suited to your financial situation and your ability to repay them. There are many options, including a home equity line of credit (HELOC).

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A HELOC is a flexible mortgage product that gives you access the amount you need, when you need it. You can use it whenever you want without having to apply for a new loan, and you pay interest only on the amount you use. The credit limit is equal to 65% of the value of your home. Keep in mind that this is the maximum amount you can borrow—but as you pay down your mortgage over the years, your available credit will change based on what you still owe.  As you pay down your mortgage, your credit limit will increase.

Are you eligible for refinancing?

A sure-fire way to refinance your mortgage

To make sure you can refinance your mortgage, you need to have your ducks in a row. A mortgage broker can help. You have to prove to the lending institution that you can repay the amount you're asking for at the time you choose to refinance. To do so, mortgage lenders require certain financial information to calculate your monthly housing and living expenses, plus your total debt. With this information, they can determine your ability to repay what you borrow.

Here's what they take into consideration:
•    Your household income (before tax)
•    Your household debt
•    The amount you want to borrow
•    Your portfolio and credit rating
•    The market value and the state (to be evaluated) of your property

Why use this tool?

Refinancing is a tool that can give you enormous freedom. But how do you know if it's right for you? What will you use it for? Lots of people dream of buying a cottage in the country for family gatherings—but that's not the only reason people refinance their mortgage. Here are the top reasons for using this financing strategy.

Renovating your home to increase its value

Refinancing your mortgage can help you increase the value of your property. You can use the money to make major renovations that will make your home more comfortable and increase its eventual selling price. A modern bathroom and a snazzy new kitchen may be expensive, but they can increase the value of your property significantly. This also applies to buying an income property.

Securing a lower mortgage rate

You might want to refinance to secure a lower mortgage rate than the one you got when you originally signed your mortgage a few years ago. If rates have fallen since then, refinancing lets you secure a lower rate and save on interest in the long term. Contact a mortgage broker to learn more about the penalties that could be involved when you refinance. Do the math to make sure you're turning a profit with this strategy.

Saving by consolidating your debts

It can be highly advantageous to refinance your mortgage to consolidate your debts, from credit card debt to personal loans. The mortgage refinancing rate will be significantly lower than the rates for these other debts, which tend to sit between 8% and 10%—or even higher when it comes to credit cards. Using a mortgage refinancing strategy is a good idea if you can save money on interest charges. Just make sure to adjust your spending and saving habits if you refinance your mortgage to consolidate your debts. It's the perfect opportunity to get your finances in order and start thinking about saving for the future.

To get an estimate on how much you could save on interest charges, use our calculator.

More good reasons!

•    Improve your financial health by paying down high-interest loans.
•    Save more by increasing your RRSP contributions and lowering your taxes.
•    Increase the value of your home by doing renovations and making improvements.
•    Put a down payment on an income property.

No matter your project, we recommend always striving to improve your situation. That way, you can take full advantage of the leverage effect. You could, for instance, lower the cost of your debt. Pipe dreams can turn into brilliant ideas when you use money from refinancing your mortgage to create value for yourself, in both the short and long term.

Learn more about the advantages of mortgage refinancing.

Key takeaways
  • Determine why you want to refinance your mortgage. Make sure the reason makes solid financial sense in both the short and medium term.
  • Take the time to consider all the products your mortgage broker suggests. Weigh the pros and cons before making a decision.
  • Calculate your monthly expenses, including the minimum payment on your debts. This will give you an idea of how much you can repay and your chances of being approved for mortgage refinancing.