Time to refinance?

Fall 2009 CSANews Issue 72  |  Posted date : Sep 22, 2009.Back to list

Quick questions to ask yourself before refinancing your mortgage

As stormy as the North American housing market has been over the past several months, there has been a silver lining underneath all of the clouds: mortgage rates.

Simply put, posted mortgage rates have come down dramatically, making the cost of buying a house much more affordable. In fact, posted rates on a five-year, fixed-rate, closed mortgage in Canada are now hovering around 5.45%; those with good credit should be able to negotiate a rate below 4%.

This is great news for anyone in the market for a first home or a vacation property. But it's also good news for those who already have a mortgage. With interest rates near all-time lows, there's never been a better time for those with good credit ratings to refinance their existing mortgage and lower their monthly interest payments.

That said, the decision to refinance isn't always cut and dried. In some cases, refinancing can actually cost more in fees and penalties than the interest you save.

How do you know whether refinancing is a good strategy for you? Ask yourself the following questions:

How high is your current interest rate?

The whole point of refinancing is to secure a lower interest rate on your mortgage than the rate you currently pay. Obviously, the bigger the spread between the rate you currently pay and the rate banks are currently offering, the more you could save by refinancing. On the other hand, if you already enjoy a low interest rate, the spread might be rather small, in which case the costs and fees associated with refinancing might not make the strategy worthwhile.

You can keep track of posted mortgage rates on a number of dedicated personal finance websites such as MSN Money (www.finance.sympatico.msn.ca) and Yahoo Finance (www.ca.finance.yahoo.com). Most major newspapers also publish posted mortgage rates in their weekend editions. Keep in mind, however, that for those with good credit, posted rates are merely a starting point—your mortgage broker or banker can often negotiate an additional discount, which can make a big difference to your refinancing considerations.

How long are you planning to stay in your existing home?

A recent survey by the U.S.-based site, www.bankrate.com found that the average closing cost on a refinancing in the United States was around $3,000. If you plan to stay in your home for several more years, chances are good that you'll recoup these closing costs in interest savings over the lifetime of your mortgage. On the other hand, if you plan to move in the next few years, closing costs might exceed any interest savings you realize.

How do you know whether refinancing will cost more than it's worth? First, check with your lender to understand exactly how much you'll have to pay, should you refinance. Then, visit an online mortgage refinancing calculator (again, MSN Money and Yahoo Finance can help you, or visit www.bankrate.com ) and determine exactly how many months it will take to recoup your costs.

Do you want to switch from a variable-rate mortgage to a fixed rate?

Fixed-rate mortgages have come down in price dramatically over the past several months. And, while some experts are predicting that fixed-rate mortgages in Canada may very well go lower still, most of the big savings are probably already reflected in current rates.

So, if you currently have a variable-rate mortgage that fluctuates with the prime lending rate (sometimes called an adjustable or "floating" rate mortgage) and would like the certainty that comes along with a fixed-rate mortgage, now could be the perfect time to make the switch. Most adjustable-rate mortgages give you the option of switching over to a fixed-rate mortgage at no cost, but check with your lender to be sure.

How good is your credit?

The current housing crisis was caused by banks lending to so-called "subprime" borrowers—people who would not normally qualify for a mortgage under traditional lending rules. Because so many of these subprime loans subsequently went sour, today's lenders have become reluctant to do business with anyone with less-than-healthy credit ratings. The opposite is also true: as banks look to repair damaged balance sheets, homeowners with excellent credit and substantial assets have more negotiating power than before.

If you fall into the latter category, you could be able to secure additional discounts on your mortgage rate, and possibly rebates on fees and other costs. This can make refinancing a lot more attractive. On the other hand, if your credit quality is poor or if it's deteriorated since you took out your original mortgage, chances are that the costs of securing a loan today are more substantial than they were two to three years ago.

How much equity do you have in your home?

If you've made significant progress toward paying down your principal, refinancing could be a good idea. For example, if your loan is now less than 80% of the value of your home, your bank will usually waive the requirement for mortgage insurance—this can save you a considerable sum over the lifetime of your mortgage. In addition, lenders could consider you a lower credit risk than before. This could enable you to negotiate a lower interest rate than the one on your original loan.

Conversely, if your home has decreased in value over the course of the current housing market downturn and has eroded your level of equity, it's probably a good idea to stand pat; in a worst-case scenario, your bank could now demand that you buy mortgage insurance. This is a particularly important consideration for anyone looking to refinance a mortgage on homes in traditional snowbird destinations such as Florida, Arizona and California. All of these regions have been particularly hard hit in the downturn, and have seen property values decline dramatically over the past 24 months.

Do you have the cash on hand to cover closing costs and fees?

As mentioned, there are a number of costs and fees involved with refinancing. The good news is that lenders will usually give you a more favourable interest rate if you pay those closing costs up front. If you don't, you'll have to roll these costs into your monthly mortgage payment, which usually means a higher interest rate.

Remember, the difference between your current interest rate and your refinance rate is critical when it comes to determining whether refinancing makes sense. So, if you've run through the numbers and are still on the fence about whether you should refinance, ask your lender what kind of interest rate you could get if you agreed to pay your costs up front. It could make all the difference to your calculations.

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Above all, remember that refinancing a mortgage is an important decision—one that can have a big implication on your long-term financial health. For that reason, it's a good idea to seek professional advice before you make your decision.

A good mortgage broker should be able to outline a number of refinancing scenarios and mortgage options for you. Working together, you should be able to determine whether refinancing your existing mortgage makes sense for you, or whether you'd be better served by sticking with the mortgage you have.

Refinancing: four steps to success

You've thought about it, analyzed your situation, considered your options and made your decision: you're ready to refinance. How do you do it? Follow these simple steps:

1. Shop around for interest rates.  Don't assume that your first offer is the best—shop around to be sure.

2. Don't accept high closing costs. Some lenders are compensating for low interest rates by boosting their closing costs. Don't play this game—take your business across the street.

3. Make sure to talk to your existing lender. They may give you a good deal just to keep your business.

4. Don't try to "time" interest rates. Trying to wait for interest rates to hit their absolute rock bottom is a sucker's game. If you've done the calculations and the numbers make sense, do it.