Refinance Tips

With today’s super low interest rates many people are considering getting out of their current mortgage to take advantage of lower rates, save a few dollars on their payment each month and pay less interest over the life of the mortgage. As a broker I actively monitor my clients mortgages and when appropriate I suggest opportunities where a refinance would benefit the client.

However, you need to be careful that refinancing does not put you in a worse financial position….it doesn’t make sense for everyone or every mortgage. Let’s talk about a few things that you need to look out for.

1. Penalties- This is the biggest expense when refinancing and will make the difference between success and disaster. When you originally got your mortgage the commitment clearly stated the penalty you would incur if you got out of your mortgage early. If you don’t have the document or can’t find the information, call your mortgage provider. There are usually two methods of calculating a penalty. The first is three month’s interest and the second is called interest rate differential (IRD). Unfortunately for you the lender will use the higher of the two methods. Let’s look at an example to show the difference. Let’s assume you are 2 years in to a 5 year mortgage. Your current rate is 4.99% and you would like to refinance to 3.99%. If the penalty is 3 months interest you can easily add up the last three month’s interest to get an idea of the penalty you will pay. In this case it is about $3,000. However in an environment where interest rates are falling, the bank will use IRD. They have lent you money and are counting on receiving interest payments on that money at the rate agreed upon (4.99% in this case). When you cancel the mortgage and return that money, they will lend it out again, but in the current market they can only lend it for 3.99%. They expect you to compensate them the difference. In our example the difference the bank would expect you to pay would be about $7,000. That is significantly different than the 3 month’s interest. In most cases the penalty will just get added on to the new mortgage which is why you need to make sure the monthly savings will be enough to cover the penalty. In this case we will be saving about $9,000 in monthly payments over the remainder of the current term which more than covers the penalty.
2. Lawyers fees - Since you will be registering a new mortgage against the property you will require the services of a lawyer. Be sure to budget about $700 for this.
3. Appraisal – The new lender will want to make sure your house is worth what you claim it is. Most appraisals range between $250-$300

As you can see there are significant expenses involved with refinancing your mortgage and depending on the situation can wipe out any benefits you would have received from the refinance. Make sure you speak with a mortgage broker to determine if a refinance makes sense for you and always contact your current lender to find out the exact penalty before you start the process. You don’t want any surprises on closing day.

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