In Canada, about 15% of Canadian homeowners refinance their homes every year for a variety of reasons. Fundamentally, when Canadians refinance, they are looking to:
- Take advantage of better mortgage terms (rate, amortization, product amenities) to manage payments
- Access equity in their property (consolidate debt)
- Remove someone from the title or ownership (Divorce or buying out a co-owner)
- Take Advantage of Invesment and Business Opportunities
There are 4 different ways to refinance your mortgage:
Cash-Out Refinance
A cash-out refinance replaces your existing mortgage with a new, larger mortgage. The difference between the new mortgage amount and the old mortgage balance is given to you as a lump sum of cash.
You end up with a single mortgage, and you start a new term with possibly different interest rates and amortization periods.
Generally, the interest rate on a cash-out refinance is lower than that on a home equity loan, reverse mortgage, or HELOC because it’s a first mortgage, which is less risky for the lender. The downside is that you usually have to break your current mortgage, which may result in substantial penalties (see How to Break a Mortgage). Consequently, before doing a cash-out refinance, contact Allen Ehlert to crunch the numbers and see if it makes sense for you in your situation.
You make regular mortgage payments that include both principal and interest, just like a standard mortgage.
Example: Major Home Renovations
Situation: A homeowner’s property has appreciated significantly, and they now have substantial equity. They want to remodel their kitchen, renovate their bathrooms, and add a new deck, but they don’t have the cash on hand to cover these costs.
Solution: The homeowner does a cash-out refinance, replacing their existing mortgage with a new one that has a higher balance. The difference between the new and old mortgage amounts is paid to them in cash, which they use to fund the renovations. The new mortgage has a fixed rate, and the homeowner benefits from the current lower interest rates.
Also see: Mortgage Cash-Out Refinance
Home Equity Loan
A home equity loan allows you to borrow a lump sum of money using your home’s equity as collateral. It is a second mortgage, separate from your original mortgage.
You have two separate loans: your original mortgage and the new home equity loan.
Typically, home equity loans have fixed interest rates, which are generally higher than first mortgage rates but lower than credit card or personal loan rates.
You repay the loan with fixed monthly payments over a set term, much like a standard mortgage.
Example: Paying for a Child’s University Education
Situation: A couple’s child has been accepted to university, and they need a lump sum to cover tuition and other education-related expenses. They have significant equity in their home but do not want to refinance their existing mortgage.
Solution: The couple takes out a home equity loan, which provides them with a lump sum at a fixed interest rate. They use this money to pay for their child’s education, and they make regular monthly payments on the home equity loan over a set term.
Home Equity Line of Credit (HELOC)
A HELOC gives you access to a revolving line of credit based on your home’s equity. You can borrow as much as you need, up to a certain limit, and repay it over time, much like a credit card.
Like a home equity loan, a HELOC is typically a second mortgage, but it’s structured as a line of credit rather than a lump-sum loan.
HELOCs usually have variable interest rates, which can change over time depending on the prime rate.
During the draw period, you can borrow and repay as needed, usually making interest-only payments. After the draw period, you enter the repayment period, where you must pay back the principal plus interest.
Example: Flexible Access to Funds For Emergency Expenses
Situation: A homeowner wants to have access to funds for ongoing home maintenance and potential emergencies, such as unexpected medical bills or car repairs, but they don’t need a large lump sum immediately.
Solution: The homeowner opens a HELOC, which provides a revolving line of credit secured by their home’s equity. They draw from the HELOC as needed, paying interest only on the amount they borrow. This flexibility allows them to manage smaller, ongoing expenses or handle emergencies without taking on more debt than necessary.
Reverse Mortgage
A Reverse Mortgage allows you to borrow a lump sum, or a series of payments up to a total of 55% of your home’s equity (depending on the program) using your home as collateral. It’s a special kind of cash-out refinancing where you don’t have to demonstrate income beyond what you need to maintain the up keep and insurance of your home.
A Reverse Mortgage is a mortgage without a defined term, unlike a Home Equity Loan or a Cash-Back Refinance. You can make repayments or you can decide to make no payments.
Reverse mortgages are offered with both fixed and variable interest rates, depending on the lender and the specific product and not all lenders offer both fixed and variable rate options.
It is possible to refinance a reverse mortgage in Canada, although it is not as common as refinancing a traditional mortgage. Refinancing a reverse mortgage involves replacing the existing ever mortgage with a new one; either with the same lender or a different lender.
Example: Retirement Income Supplementation
Situation: A 70-year-old retiree has a home worth $800,000 but has limited savings and no pension. The retiree needs additional income to cover their living expenses and healthcare costs.
Solution: The retiree takes out a reverse mortgage, allowing the retiree to access a portion of their home’s equity without having to sell their home or make monthly payments. The retiree receives regular payments or a lump sum, which is used to supplement their retirement income. The reverse mortgage is repaid when they sell the home, move out, or pass away.
NOTE: Reverse Mortgages are being used today in sophisticated ways to acquire additional properties. hedge against inflation, legally avoid taxation, and support grey divorce. Contact Allen Ehlert for details.
See Also:
- Reverse Mortgages and the Affluent Retiree
- Reverse Mortgage: Cushion Against Inflation
- Reverse Mortgage to a Second Dream Home
- Struggling Financially as a Senior
Summary of Differences
A Cash-Out Refinance and a Home Equity Loan provide a lump sum, while a HELOC provides a line of credit. A Reverse Mortgage provides either a lump sum or a series of payments.
A Cash-Out Refinance and a Reverse Mortgage replace your first or existing mortgage, while Home Equity Loans and HELOCS are typically second mortgages.
Cash-Out Refinances usually offer the lowest interest rates (but are frequently accompanied with the highest penalties when an existing mortgage needs to be broken), followed by Home Equity Loans, Reverse Mortgages, and HELOCS.
Cash-Out refinances had Home Equity Loans have fixed repayment terms, while HELOCS offer more flexibility during the draw period but may have a repayment phase later. Reverse Mortgages may be re-payed or payment can be suspended until the borrower leaves the home.
