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Is it time to refinance? Real Estate Market Review - October 2003

This is the short introduction, where we talk about what the article is going to talk about. Dope.

Mortgage rates are at record lows and house prices are at record highs. This combination makes it a great time to pull equity out of your home to consolidate debt, to renovate, or to send yourself on a nice year-long vacation.

A year-long vacation sounds like the way to go, but if you are like most homeowners you have other priorities. You may need to replace the furnace, fix the roof, pay off that new sofa you bought on a deferred payment plan or just pay off all your credit card bills.

Depending on your financial situation, it may make sense to take a serious look at tapping into the equity in your home. There are several ways to approach this: You can increase your existing mortgage, arrange a secured line of credit, arrange a second mortgage, or pay off your entire mortgage and start fresh.

The hardest part of refinancing is determining how to structure your new financing. Every situation is unique and the ways to get equity out of your home are many. There are three things you need to analyze when you are deciding how to proceed. You will want to determine your transaction costs, your interest rate, and your monthly payments. If you can quantify these items then you can choose which option makes the most sense.

Option 1: Increase your existing mortgage

By increasing your existing mortgage you will avoid any penalties that may be associated with breaking your mortgage early — and you can borrow up to 90% of the value of your home. Typically a lender will offer to give you a blended interest rate with this option. By taking the blended rate you avoid paying any penalties but the banks will usually calculate the blended rate to their advantage. Costs with this option will usually include legal fees, appraisal fees and CMHC (Canadian Mortgage and Housing Corp.) insurance premiums (if you are borrowing more than 75% of the value of your home). Monthly payments will usually be affordable with this option because you can choose to amortize your mortgage for up to 25 years.

Option 2: Arrange a secured line of credit

This option leaves your existing mortgage as is. The line of credit will become a second mortgage on your home. Most lenders will offer to lend up to 75% of the value of your home less the balance on your first mortgage. Costs to arrange this line of credit will usually include an appraisal fee and legal fees but some lenders may have special promotions where they will absorb some of these costs for you. Interest rates for secured lines of credit are usually at prime but I have seen some lenders try to charge rates as high as prime plus 2%. Minimum monthly payments on a secured line of credit are usually interest-only payments. You have the option to pay down the principal at any time but you do not have to.

Option 3: Arrange a second mortgage

There are institutional lenders, and private lenders, who will lend up to 85% of the value of a home, less the balance on the first mortgage. Costs for this type of financing usually include appraisal fees, legal fees, lenders fees and brokerage fees. Interest rates for this type of financing are usually fairly high. Rates can range from 11% to 14% or more, depending on the amount of risk to the lender. These mortgages are typically used for people who may not qualify for traditional bank financing due to a poor credit history or a lack of stable income. Payments on second mortgages can be amortized over 25 years and some lenders will even allow just monthly interest payments. While this is not inexpensive financing it is still cheaper than most credit cards and it usually will improve the borrowers cash flow if the funds are used to consolidate other debts.

Option 4: Arrange a new first mortgage

Quite often this is the easiest way to refinance your home because you are starting fresh. The biggest unknown cost to this scenario is the cost of paying out your existing mortgage early. You should talk to your existing lender to determine what this cost will be. (Usually it will be the greater of a three-month interest penalty or an interest rate differential.) Other costs will include appraisal fees, legal fees and CMHC insurance premiums if you borrow more than 75% of the value of your home. Interest rates for a new first mortgage will be the best discounted rates available in the market and you can choose to amortize the payments for up to 25 years.

As you can see there are many options available to borrowers. You really need to sit down and discuss your situation with a trusted banker or mortgage broker to decide what option makes the most sense for your situation.

If you have a lot of high-interest debt, want to renovate, or take that year long vacation, now is definitely the time to consider refinancing because home prices are up and interest rates are down — a perfect combination for borrowers.