Here's What You Need To Know About Refinancing
So… Let’s address the first and most basic of questions right out of the gate because I do get asked this often:
What is refinancing anyway?
Refinancing is basically replacing your current mortgage with a shiny new loan – One with a lower-interest and/or term hopefully. Your new lender takes over your old mortgage and pays it off, whilst you pay them instead. Voila, that’s mortgage refinancing in a nutshell!
What do I need to refinance?
A great credit score is helpful to start. (Though not required in many circumstances depending on the goal of the refinance) You’ll see a lot of sites recommending that you personally check your credit before applying for a refinance. The reason you won’t hear me make such a recommendation here is that what you see in your credit as a consumer is different from what an underwriter will see. This is why I recommend just having a professional credit review performed by your loan officer early on, so you can identify potential mistakes and/or issues without wasting a bunch of time.
If your credit score is a bit, well, “Challenged”, then I suggest taking a closer look at the Credit Solutions page on this site. A lot of folks throw in the towel thinking that they cannot refinance due to previous credit issues. However, these days there are more options than you might realize that allow you to rapidly improve your credit. No, it’s not a magic wand… But it’s quite powerful, and definitely worth further investigation: Click here to learn more about how to improve credit.
Proof of income is another requirement. Lenders will want to see 1 to 2 recent pay stubs and at least two years’ tax returns (Your Notice of Assessment) from Canada Revenue Agency (CRA). Your debt-to-income ratio needs to be fairly strong, too. Up to 44% should be okay, depending on the lender. What the heck is a debt service ratio? It’s pretty simple actually, the lender will calculate how much of your income each month is going toward debts. There’s a simple calculator at this link provided by Canada Mortgage and Housing Corporation (CMHC). If you’re not sure if you are calculating everything correctly, I’d be happy to crunch the numbers for you. Quick, no pressure, and you’ll have a definitive answer.
Speaking of ratios, how’s your loan-to-value ratio? That’s going to come into play too. Your loan-to-value ratio is simply a calculation of how much you currently owe on your existing mortgage in comparison to how much your home is worth if it were to sell today. Lenders want at least 20% equity in your home, unless you are simply switching your mortgage and not changing the terms of the current loan. However, here in the real world where the rest of us live, some lenders understand that this is not reflective of reality, and will lend up to 80% the value of your home but allow your debt-to-income ratio to go as high as 50% and allow a second mortgage to 90% of the value of your home.
Be aware going in though, that if you wish to borrow more than 80% of what your home is worth and/or go up to 50% debt-to-income ratio, those loans do come with higher interest rates and fees.
Let’s Talk Money. It may come as no great surprise to you, but very little in life comes without a cost. So, it won’t be a shocker that refinancing a mortgage has its own costs to consider. Some lenders charge a fee for the process, whilst others waive this and instead, you’ll pay a closing cost. This cost can vary tremendously from one program to the next. Personally, I like to give my clients multiple options to chose from if possible.
Despite the costs associated though, the process can certainly be more than worth it, so long as you’re staying at the home long enough to recoup your initial investment in the form of monthly savings. For example if we can drop your monthly payment by $150, and you spent $3000 on a refinance, (In many cases, you don’t have any out of pocket though. Most lenders allow you to roll those fees back into the new loan) then how many months would it take for you to realize more than $3000 in savings? (21 months in this particular instance)
The age-old saying is that any time you can recoup your costs within 2 years or less, then you’re looking at a no-brainer scenario. Even 3 – 4 years is still considered a smart decision, but ultimately, the real test for many homeowners is “how long will you stay at your current home”? If you’re thinking you might be moving within the next year or 2, then a refinance might not be the best option for you at the moment. (There are exceptions to this rule of course, but we’d need to chat about your unique circumstances to determine the best option)
If you’re finding yourself strapped for cash every month and are struggling to make the mortgage payments, then lowering your monthly payments is something that’s definitely worth looking into.
Another common reason homeowners refinance is to save (Significantly) on the overall cost of their mortgage. Switching to a 15-year term mortgage means bigger savings on interest in the long run, as well as getting out of debt sooner. A double win.
Of course, this isn’t an option that would work for everyone. It means a higher payment every month and that’s something you’d need to budget for. However, for those who can swing the higher monthly payment, it can certainly be a nice feeling looking at all that cash saved by getting out of debt sooner.
Finally, we have the most commonly requested version of the refinance – Accessing cash!
Yep, there are hundreds of reasons you might find yourself needing to get in touch with some extra money – Paying off high-interest credit card debt, home improvement, emergencies, and some even use it for a much-needed vacation! (Obviously, this last one is not the intended purpose of a refinance, but hey, I don’t judge!)
This brings us back to that magic 80% loan-to-value ratio I mentioned earlier. If you’re wanting to access cash, your rates and/or costs will generally go up as you exceed that magic 80%. Keep that in mind as you consider which option will be best for you.
So what’s the catch?
I mean, smaller monthly repayments, an option for pulling out cash, or even getting out of debt sooner and with more (Much) cash in your pocket! Sounds amazing, doesn’t it? Well, in the name of full disclosure, do remember that small monthly payments typically mean a bigger, longer loan in the end. Not trying to be a party pooper here, but I want you to consider all the angles before hopping in both feet first!
Where on Earth Do I Start?
Hands down the best thing you can do when starting out is getting a credit analysis. It doesn’t do much good to guess at what you ‘might’ qualify for does it? Especially once you learn that over half of all credit reports in Canada have errors on them. You won’t know if your own credit is being dragged down artificially until you have a professional take a look. Once you know what your credit looks like, you’ll be better positioned to begin your investigation.
Once you’ve reached this stage, you’re ready to begin chatting with lenders and checking out mortgage quotes. I recommend that you read this article before you speak with anyone: How To Tell The Good Lenders From The Bad. This will prime you with some good tips on what to be on the look-out for.
What Do I Need?
After you get the process started, most lenders will request the following if you wish to proceed with a refinance: (Note: This is a general rule of thumb. There are some specialized programs that require more, and others that require less)
Name, Date of birth, Social Insurance #
Asset information, such as recent bank statements
Recent pay stubs
Current mortgage documentation
Last 2 years tax returns
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