Managing your finances can be challenging these days and it is not uncommon for individuals or families to find themselves carrying an uncomfortable amount of high-interest debt or needing to do repairs or updates on their home without the savings to handle the cost. If you have owned your home for a few years and have built up some equity, you may have the option to refinance your mortgage to use some of that equity to help out.
Let's look at the Hows and Whys of Refinancing to see if it's an option that works with your circumstances!
Can you Refinance?
First and foremost you need to have equity built up in the property to draw from.
EQUITY = VALUE OF PROPERTY - MORTGAGE ON PROPERTY
New mortgage rules that have come into place over the past several years only allow a refinance up to 80% of the value of the property. What does this mean? For example, if you have a property that is worth $400,000, then you can only finance (or re-finance) it for a maximum of $320,000 (or 80% of the value). If you originally purchased your home with a minimal downpayment, it may take you several years to have enough equity built up to be able to refinance.
There are other options available through alternative lenders and products but that won't be covered in this article.
How do you Refinance?
So, let's say that you have enough equity built up in your home that you can refinance to draw additional funds, what does that look like? There are a few different options available, let's use the following example: VALUE OF HOME = $400,000 EXISTING MORTGAGE = $250,000 EXISTING PAYMENT $1500/MTH ADDITIONAL FUNDS NEEDED = $70,000
- Break your existing mortgage and put a new one in place for the entire amount of the new loan. This is often a preferred choice as you only have to worry about one mortgage amount and one payment, however, it can mean potentially high penalties to pay if the existing mortgage isn't due for renewal.
- using our example above, you pay off the existing loan of $250,000, potentially pay a penalty of $2500 (rough guesstimate) and now have a new mortgage loan of $320,000. Your new payment is $1600/ mth (assuming rates haven't changed) and you have the extra $70,000 to pay down debt / renovate your home or invest.
- Add a second "tier" onto your existing first mortgage for the additional funds you need. Many lenders have the option of having more than one mortgage loan under a first mortgage "charge" (different from a second mortgage). Your existing mortgage terms stay the same, meaning the amount, payment and maturity date do not change but you have a "second" loan with a different amount, payment and maturity date along with it.
- You still have your existing mortgage loan of $250,000 with the $1500 / month payment but you now also have another loan of $70,000 with a monthly payment of $350.00
- Add a second "mortgage". The difference between this option and the one above is that a lender registers a second "charge" against your property, your first mortgage does not change but you now have a second loan and monthly payment similar to option #2. This is a more costly option however, as the interest rate is typically significantly higher than refinancing under a first mortgage and there can be fees involved.
- you still have your existing mortgage loan of $250,000 with the $1500 / month payment but you now also have another loan of $70,000 with a monthly payment of $580.00
Should you Refinance?
Let's take the judgment out of why you are in the situation you're in because we all know, life happens and hey, I'm pretty sure the majority of us have all been there! The question is, does it make sense to choose refinancing from a financial point of view? The questions that you need to consider (and talk to your mortgage specialist about) is what will the refinance accomplish and what are the short and long term impacts of making this decision?
If you are carrying $70,000 in high-interest debt (car loans, credit cards, etc.), you could easily free up over $1000 /month in payments. You can always consider shortening the amortization of the new loan which would still save you money each month and pay down this new debt faster.
If you are wanting or needing to do some home improvements, then the plus of refinancing is that you are increasing the value of your property (depending on what type of improvements you are making... kitchen YES, pool NOT SO MUCH) and therefore not really hurting your overall financial picture.
If you are looking to make some investments with the extra funds, then as long as the return on that is higher than what you're paying on your mortgage, it makes financial sense. Leveraging is a powerful tool but has some additional risks associated with it. It's always a good idea to sit down with your financial advisor/mortgage specialist to talk things through before making this kind of decision.
Finances are stressful and confusing and can be hard to navigate alone, sitting down with an independant Mortgage Specialist is a great first step in reviewing your options and deciding which is best for you!
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