David Larock in Mortgages and Finance
I’ve had a lot of calls lately from borrowers who are wondering if now is a good time to refinance their mortgage, so I thought I’d write a summary to help my readers answer that question. Today’s post will outline a step-by-step process and offer some suggestions where appropriate (this exercise should take you 30 minutes or less). You may find this information to be complex so feel free to call me and we’ll walk through the analysis together over the phone. Here then, is my guide to determining whether now is a good time to refinance your mortgage.
1. Calculate your mortgage penalty. If you have a variable-rate mortgage, your lender will normally charge you three-months interest on your current mortgage balance. If your mortgage rate is fixed, your lender will charge you the greater of three-months interest or “interest rate differential” (IRD), also using your current balance. Explaining the formula for IRD is complicated, so I suggest that you use my penalty calculator as a shortcut. If you have a fixed interest rate and your mortgage is with a Big Five bank, enter the posted rate that was offered at the time you obtained your mortgage in the “Current interest rate” field (unfortunately, this will arbitrarily double the size of your penalty, which isn’t fair, but until Mr. Flaherty addresses this issue, there’s not much we can do about it). My calculator will give you a reasonable estimate, which is a good start, but if you decide to refinance, you’ll eventually have to call your lender to get the exact amount.
Suggestion: Keep in mind that if you are planning to pay out your existing mortgage, you should first take advantage of your lump sum prepayment allowance as outlined in your mortgage terms (lenders will typically allow you to make additional lump sum payments that are between 15 to 20% of your original mortgage balance each year). If you have a line of credit (which can be paid off at any time with no penalty), consider using it to pay down your mortgage before you discharge. This will lower your mortgage balance (which is used to calculate your penalty) and you can roll that line-of-credit debt into your new mortgage in short order. While most borrowers don’t do this, it’s an easy way to reduce the size of your payout penalty.
2. Compare your current rate to today’s rates. Generally speaking, if you have a five-year fixed-rate mortgage at 5% or higher, or a variable-rate mortgage priced at prime or higher, a refinance is well worth considering. In simple terms, you want the savings from your new rate to be greater than the cost of any penalty plus refinancing costs such as legal fees, appraisals, etc. ($750 is a reasonable estimate for refinancing costs). My mortgage cost comparison calculator will help you follow this step.
Suggestion: If you’re planning on borrowing at a variable rate as part of your refinance, increase it by between .75% and 1.5% when comparing it to your existing rate. Assuming a higher average variable rate ensures that you are making a conservative estimate of any potential savings.
3. Add the savings realized from including any other debts in your refinance. If you have other credit-card or unsecured debts with higher interest rates that you are planning to roll into your new mortgage, don’t forget to factor in these savings as well. Refinancing high-interest debt into your mortgage will increase your cash flow and save you money, even in many cases where breaking your existing mortgage involves a substantial payout penalty. If you want help organizing your financial details so you can see how much a refinance will save you overall, feel free to use my debt consolidation calculator.
Suggestion: If you currently have an insured mortgage and you want to increase your loan amount, you will be required to pay a top-up premium on the difference between your original loan amount and your new loan amount. The fee CMHC charges depends on the amount of your equity remaining in the property. Here is the pricing table they use (see column on right). Be sure to factor the cost of your top-up premium into your refinancing costs.
The most important tip I can give you: For a refinance to make sense, it should both save you money and increase the amount of cash you have left in your pocket at the end of the month. As you undertake your refinance, and before you get used to having the newly saved extra money around, consider putting some or all of it back into your mortgage. You have the option of setting your scheduled payment above the lender’s required minimum and doing so will help you become debt free faster.
To use an example, assume that you are refinancing into a new $300,000 mortgage at the current variable rate of 2.25% using a 25-year amortization. If you set your mortgage payments higher by pretending that you are paying the current five-year fixed rate of 4%, and if the variable rate averages 3% over your five-year mortgage period, you will have paid off a little more than $10,000 of extra principal in just five years by the time your renewal rolls around. In most cases this is a painless exercise because chances are your old mortgage rate was higher than 4%. So you end up with more cash in your pocket AND you’ll be paying off your mortgage faster.
I realize that today’s post is fairly technical, but if you use the calculators and tools I have provided, you should be able to work through the suggested steps. Having said that however, if you’d rather have me take you through the process personally, just send me an email or call. Instead of wondering whether you could be saving money and paying off your debts faster by undertaking a refinance, let’s put your current borrowing costs to the test and see what the numbers say.
David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog (movesmartly.com) and on his own blog (integratedmortgageplanners.com/blog). Email Dave
March 9, 2011Mortgage |