August 22, 2012
Matthew Chan, CA MBA AMP
If you're in a fixed-rate mortgage from last year or earlier, chances are you're at a fixed rate higher than the going rates today. We're still in the midst of all-time low interest rates. It's tempting to think you might be able to prune your expenses or cut the term of your mortgage by refinancing early.
But before you decide to refinance your mortgage, here are some tips on how to proceed so you won't be hit with any nasty surprises.
Step 1. Contact a mortgage professional
Choose your mortgage broker carefully. Here are some things to consider:
- How long has this mortgage broker been in the business?
- Does this mortgage broker specialize in refinancing?
- Is this person a full-time (vs a part-time) mortgage broker?
- Is this an independent mortgage broker or one employed by a lender?
- What type of professional designations or educational background does this mortgage broker have?
Step 2. Determine why you would like to refinance
Besides getting a better rate, you should consider other reasons for refinancing your mortgage.
- Do you have some unsecured debt that you would like to consolidate?
- Would you like to take out some money for investment purposes?
- Are you very unhappy with your current lender?
By determining your reasons for refinancing, you're in a better position to evaluate your options.
Step 3. Determine the short-term and long-term goals for your home
Before refinancing your mortgage, first evaluate what your goals are for your current home. If you're looking to sell and purchase a new home soon, consider holding off your refinance until you purchase your new home. You'd be saving yourself the time and trouble by applying for a new mortgage just once (when you buy your new home) instead of twice (the refinance and then buying your new home).
Step 4. Determine what the penalty is to refinance
This is usually the biggest obstacle. In a fixed-rate mortgage, you are contractually obliged to keep your mortgage until it's up for renewal. As a result, if you refinance it before maturity, the lender charges a penalty. A penalty might be reduced or even eliminated if the refinance is done with the same lender (some lenders have options for an early renewal).
The payout penalty is usually the greater of two numbers:1) 3 months' interest, or 2) Interest Rate Differential (IRD).
The IRD is probably one of the most misunderstood terms in the mortgage industry. It is explained by a major bank's website in this way:
The IRD amount is equivalent to the difference between your
annual interest rate and the posted interest rate on a mortgage
that is closest to the remainder of the term less any rate discount
you received, multiplied by the amount being prepaid, and
multiplied by the time that is remaining on the term.
A full explanation of the IRD process is beyond the scope of this article. However, the tactics that banks use to inflate penalties are very real. Here's a great article on the subject.
Note: Some "no frill" mortgages simply don't allow refinancing. If you have such a mortgage, check the terms and conditions.
Step 5. Calculate the real cost of refinancing your mortgage
Once you know the penalty amount and the rate you are eligible to get in the market today, you should be able to evaluate if it's worthwhile to refinance. At this stage, you should lean on your mortgage broker to evaluate the figures and provide some suggestions.
Even if the penalty for refinancing your mortgage is higher than your savings with the lower rate, it could still be worthwhile to consider a refinance for the following reasons:
- You are consolidating high-interest consumer debt (credit cards, personal loans, etc.) such that your overall cost of borrowing is lower after refinancing your mortgage.
- You are concerned about interest rates moving up, so by refinancing to a longer-term mortgage you expect to save money over the long term if rates move up in the future.
In some cases, a mortgage refinance can save thousands of dollars. At the current low interest rates, it's definitely worth checking with an independent mortgage broker to see if refinancing makes sense for you.
Matthew Chan has been a licensed mortgage broker since 2004 and has served on the Board of Directors for MBABC. Before becoming a mortgage professional, Matt earned a Chartered Accountant designation with a Big Four accounting firm and an MBA from the Rotman School of Management at the U of T. Canadian Mortgage Professional (CMP) magazine has included him in its 2012 Top 75 Brokers list.