For many homeowners, once you have set up your mortgage, it's generally out of sight and out of mind: the payments come out of the bank account, and the rate and term you or your mortgage broker worked to secure you is all but forgotten.
Sure, we all ponder once in a while whether we're getting the best rate, but more often than not it's the call from people like me gently reminding you that your mortgage is up for renewal that makes you question whether you're getting the best deal.
But here's the rub: You don't need to wait until your next renewal. Indeed, with interest rates hitting all-time lows in recent years, refinancing can lead to substantial savings and more financial breathing room -- even with with the penalties that lenders charge when you make changes before your renewal.
There are several reasons to think about refinancing your home. The most common include gaining access to the equity in your home and/or reducing debt, making renovations or major repairs and life-changing events -- and of course to take advantage of low interest rates.
If you have accumulated a significant amount of debt and it has become difficult to manage -- no matter how long you have been in your home or are planning to stay -- you should be thinking of refinancing. Carrying excessive debt while owning a home can put you at risk of missing payments and/or compromising your credit score, which will put your financial future at risk.
According to Statistics Canada the ratio of household credit-market debt to disposable income, the most common measure of the debt load, rose to 165.4 per cenet in the final quarter of 2015. In other words, consumers held more than $1.65 in debt for every dollar of annual disposable income -- a pretty scary number!
However, if you are a homeowner, there may be a light at the end of the dark tunnel of debt. Homeowners can opt to "cash out" by refinancing. A cash-out refinance replaces your existing mortgage with a new larger mortgage, and you (the borrower) take the difference in cash up to a maximum of 80-85 per cent.
So basically you tap into your home's equity by taking out a loan on the paid off portion of home. This can be a great debt reduction strategy as it often lowers the interest rate you are paying on the money you owe.
To put this into context, 66 per cent of Canadians have five-year mortgage terms and a 25-year amortization period. The average mortgage rate based on these terms is 4.64. This average five-year rate is approximately 10 per cent less than the average credit card interest rate (14.3 per cent). This is because credit card debt is perceived as riskier than mortgage debt, and credit card companies charge interest accordingly. So moving that debt can effectively increase your cash-flow even though the debt is re-amortized.
According to ratehub.ca, of the 10 per cent of Canadians who refinanced their mortgages last year, 62 per cent cited debt consolidation or repayment as the main reason for their refinance - because consolidating high interest debt -- like credit card balances and/or loans -- into a low interest mortgage can save you thousands in interest payments.
The only catch is that refinancing as a debt reduction strategy could extend your mortgage amortization.
The same sort of principle applies to renovations, repairs and/or major life changes -- such as you or your childrens' education. Basically, you are using the equity you have built in your home to finance another portion of your life and/or your future. Since your home is likely your most significant investment, renovations are a great way to increase your property value. The same thought process should also apply to investing in an education. Make sure to crunch the numbers beforehand and have a budget in place.
If you plan to seriously consider refinancing as an option for these or countless other reasons, make sure you are prepared. First, find out how much the balance of your home is, then compare your home to a recent sale in the neighborhood and use the sale price as a general indicator of the value of your home -- if you own less than 20 per cent of your home, refinancing will not be the best option for you.
Second, make sure your credit is in good shape: The better your credit, the better rate you can expect. This is not to say that if your credit is poor you cannot refinance; you are still able to refinance your home with poor credit. However, you will need to consider the rate you are eligible for based on your credit score as well as the fees involved in completing the transaction to determine whether it makes sense for you.
Third, refinancing your home is equivalent to applying for a new loan, so you need to have all your documents in order. This includes your mortgage statement, the last property tax assessment from your respective city, your job letter, pay statement and possibly your CRA Notice of Assessments from the past two years.
Lastly, the term is just as important as the rate: Don't let a great rate distract you and lock you in for years longer then you initially planned.
All of that being said, no mortgage is the same. How much you are able to save by refinancing breaks down into which components of an existing mortgage are flexible and which parts aren't.
Penalties are a prime example. These are often written in stone and will not be waived, but don't let them deter you. Start by asking a mortgage broker so that you know the numbers. Breaking your contract for a lower interest rate can save you a lot money over time, and depending on the penalty and the size of your outstanding mortgage and/or outstanding debt, it could be worth your while.
If you hold a variable rate mortgage, then expect to pay a penalty of three month's interest, and if you hold a fixed rate mortgage, then you will pay the greater of three months' interest or the interest rate differential penalty. Interest rate differential is the difference between the original interest and the interest rate the lender can charge today.
It can be a complicated calculation and most lenders have their own specific way of calculating the penalty. To find out how much it would cost to break your mortgage, you can contact your lender directly or a mortgage broker.
Overall your best bet is to think long term and talk to a mortgage professional about your options while interest rates are low -- whether you are up for renewal or not! If you plan to stay in your home for a reasonable amount of time, then refinancing may be a great option for you. This may require a change -- and it may seem like a hassle to go through the process -- but it could mean a little bit more financial freedom in the future, and a little less day-to-day stress over your finances.
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Before any fun can be had, it's best to use that remaining money to pay off any and all remaining debts that may be outstanding, starting with the debt with the highest interest. At the end of 2012, the average consumer debt load in Canada was $27,485 — a six per cent increase over the previous year and the fastest increase since 2009. Sure, such financial housekeeping seems boring and monotonous, but you'll thank yourself later. After all, financial freedom when other debt still hangs over you is nothing but a facade and the longer such debt is avoided and ignored while you live the high life, the sooner you'll be in an even deeper financial hole.
A number of financial experts and personal finance articles recommend paying off your mortgage before investing in your retirement, but once your mortgage is paid off, why not allow the money you are now saving to grow even further in an investment to put towards retirement? There are always a number of investment options to choose from, whether it be high risk high reward stocks, GICs, savings accounts, or mutual funds. What you choose is dependent on your risk tolerance and investment knowledge and your risk tolerance depends on how long the money will stay invested. More time means you can afford to take higher losses, but if you plan to cash out, you'll want to keep your losses to a minimum.
Once all outstanding debt is paid off, it's time to have some fun and live your dreams. An around the world ticket can be purchased through travel websites for less than you may think. The cost is determined by the number of countries you plan to visit, the class of your cabin and the total mileage the plane will be traveling. You'll also want to consider the flexibility that your trip allows and possibly using discount airlines, buses, or trains for shorter distances on your trip if money is still a main concern. An around the world cruise is also an option if money is no object and you want to live it up, with costs dependent mainly on your steerage class with trips ranging from $20,000 to over $100,000 depending on the cruise line and the type of room chosen.
Maybe you hate your job or maybe you just want to spend more time with the family; either way, no longer having the financial burden of a mortgage means you can start working the way you want. You can plan to retire sooner, thanks to all that extra money, maybe consider working part-time or even reinvest in yourself by changing jobs and doing what you always wanted to do or starting your own business and becoming a true entrepreneur.
Depending on how early you get your ducks in a row, paying off your mortgage may line right up with your kids, or possibly your grandchildren, going off to university. With the cost of tuition and living on your own being around $80,000, the kids will need as much help as they can get. If your kids have yet to reach university age, you can use your extra funds to make the maximum RESP contributions, as often paying a mortgage is a major barrier to parents making the real impactful contributions they want to their kids' education.
You may want to take that extra money and reinvest in your home. Those long planned renovations you always wanted to do can finally be moved to the forefront now. It's a great way to increase the value of your home if you sell it down the road. You could even put the renovation expenses on a line of credit and pay them off like you did your mortgage for a time.
Speaking of selling your home, many retirees realize that their home is actually more spacious than they need it to be, so it's common for many of them to downsize. The money you save from the sale and subsequent downsizing will only add to your financial options. The world is your oyster; now go out and claim it!
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