The 4 Reasons Everyone Is Refinancing Now. Should You?
Updated: Jun 5, 2020
“It’s been said that we cannot predict the future, but the best way to predict it is perhaps to prepare for it. The rate of change has never ever been this fast and will never ever be this slow again.” Anders Sorman-Nilsson is an Australian futurist whose client roster reads like the Fortune 500 list. I first heard him speak at Toronto’s Scotiabank Convention Centre in 2016 and was blown away by his story and strategic process.
In these volatile times, forward-thinking Canadians are refinancing their mortgages as a strategy to help prepare for the uncertain weeks and months ahead. Refinancing takes many forms but is always a reconfiguration of the terms of borrowing. It involves applying for, and choosing, new financing to replace your existing debt obligation.
Refinancing gives you options. Not the put/call kind, although many of the tried-and-true principles of investing also apply to credit (your risk tolerance and time horizon matter here too). Taking advantage of one or more of these refinancing options could strengthen your financial position.
1. Interest savings
In recent weeks, mortgage rates dropped to historic lows last seen during the 2008 financial crisis. Borrowers not yet up for renewal may want to consider breaking early to take advantage of the interest savings currently available. Even where penalties are in the tens of thousands the savings can exceed the cost, especially for those who renewed in 2018 when rates peaked, or for those consolidating other higher interest debt. Canadians refinancing today should consider the benefits of a variable rate, which allows for even more savings if prime rate continues to fall, and often the ability to lock in if prime moves back up. Consider applying with a monoline lender, many of which are funded by the major banks and provide favourable terms, similar to the relationship between popular mobile service providers.
2. Risk diversification
It’s why we buy mutual funds, ETFs, and real estate, and why the one-percenters invest also in the private markets; yet this strategy, which is a given for so many investors, is seldom considered by borrowers applying for a mortgage. If the economy and personal circumstances can change in a matter of weeks, is it truly “safer” to choose a mortgage fixed for five years, as the vast majority of Canadians do? Refinancing allows you to restructure your mortgage terms to better suit your risk tolerance and objectives. For example, consider layering smaller mortgages with 2, 3, or 5 year fixed and variable terms. This reduces interest rate risk while allowing you to stagger renewals and pay off portions with anticipated future income (such as large bonuses) all with lower individual penalties.
3. Cash flow
For most people a mortgage payment is their biggest budget expense. Refinancing to lower that amount can free up cash flow for day care or medical expenses, to pay higher interest debt, or for investment opportunities. If you’re already on an accelerated payment schedule or have made prepayments in the past, it may be possible to lower your payments without refinancing. Otherwise this can be achieved by reamortizing to 25, 30, or even 35 years, depending on the existing terms. Some lenders also offer interest-only payments which can be advantageous for borrowers with inconsistent income, such as seasonal employment, or for anyone whose funds are better utilized elsewhere. In addition, choosing a lender with prepayment options allows maximum flexibility to pay down your mortgage when you want to.
4. Contingency planning
The best time to refinance is before you have to, because credit’s unfortunate irony is that when you need it, you’re least likely to qualify. Refinancing allows you to add a HELOC (home equity line of credit) for emergency use, but also for renovations, downpayment on another property, leveraging to invest, and many other purposes. HELOCs typically have interest-only payments at rates more attractive than other forms of credit, and can be readvanced or paid down as needed. In addition to a HELOC consider adding life, critical illness, and disability coverage to your HELOC or mortgage, to ensure you can continue to meet your payment obligations if the worst occurs. It’s also possible to obtain coverage that moves with you from lender to lender without having to reapply.
SHOULD YOU REFINANCE?
It depends - on your personal financial situation, your goals, and how you want to get there. For example, combining reduced payments with automatic prepayments is an excellent way to save on interest with the option to free up immediate cash flow when necessary. Some other considerations: refinancing can have tax implications, affect mortgage default insurance, and may impact health insurance coverage if tied to your existing mortgage. Borrowers should be prepared to pay a penalty for breaking their current term, which can sometimes be capitalized on the new loan amount if preferred. There are also discharge, appraisal, and legal fees, although it’s common for the new lender to rebate some or all of those charges. If the benefits outweigh the cost, refinancing can be an excellent solution for many Canadians.
The time to act is now because rates have already started to increase as financial institutions rush to shore up their liquidity in response to market shocks. Prime rate remains low but lender specials and discounts are decreasing. COVID-19 has made it difficult for branches, appraisers, and lawyers to conduct business so borrowers should expect delays and possible closures. Purchases take priority over refinances due to their defined closing dates, so it may also take longer for lenders to process your application.
The best strategy is the one that works for you and allows you to adapt to any changes in your own life circumstances. For many Canadians unsure about future sources of income, that goal is to ensure they can continue to provide necessities for their family and remain in their home during the weeks and months ahead. Others are looking to dive deeper into the real estate and stock markets while they have comparatively more purchasing power.
There is a light at the end of the COVID-19 tunnel. But how bright, and how long the tunnel stretches, remains to be seen. When the markets take a beating, money managers will frequently tell you "stay invested, don’t make today’s losses permanent" or, "buy now, when stocks are on sale." This investment advice makes sense for many people - how are you being strategic with your mortgage? Connect with me on social @laurenpye.ca or email me for a free strategic financing review: firstname.lastname@example.org
What are your goals and how are you strategizing for the future?