Refinancing means replacing your mortgage with a new, usually larger one secured on the same home. People do it to take equity out for renovations or other big expenses, to consolidate expensive debt, or to change the rate or amortization in the middle of a term. It can save a lot of money, but it has rules and costs that a simple rate comparison doesn’t show.
The rules
You can borrow up to 80% of your home’s value
When you refinance, the new mortgage can usually be at most 80% of the home’s appraised value. That’s the legal maximum for a mortgage without default insurance at federally regulated lenders, and the lender will recalculate the loan-to-value with a fresh appraisal. In other words, you must keep at least 20% equity in the home.
New money available ≈ home value × 80% − current mortgage balance − other loans secured on the home
A second mortgage or a home equity line of credit secured on the home counts toward the 80% too. Costs you roll into the new mortgage, such as the penalty, use up part of that room.
You must pass the stress test again
Unlike a straight renewal or switch, a refinance is new borrowing, so you re-qualify. Banks and other federally regulated lenders test you at the greater of your contract rate plus 2% or 5.25%, and your housing costs and total debts must fit within their limits at that rate. If your income has dropped or your debts have grown, you may qualify for less than 80%. Try the stress test calculator.
The HELOC part is capped at 65%
Many refinances are set up as a combined plan: an amortizing mortgage plus a revolving home equity line of credit (HELOC) under one registered charge. OSFI expects federally regulated lenders to keep the revolving, interest-only HELOC part to at most 65% of the home’s value. You can still borrow up to 80% in total, but anything above 65% must be in an amortizing mortgage that you pay down on a schedule.
What refinancing costs
- Prepayment penalty: if you refinance in the middle of a closed term, you’re breaking your mortgage. That usually means the greater of three months’ interest or the interest rate differential (IRD), and it can run to thousands of dollars. Estimate it with the penalty calculator and read how prepayment penalties work.
- Appraisal: the lender needs a current value.
- Legal fees, title search and title insurance: a lawyer or notary registers the new mortgage.
- Discharge fee: if you move to a new lender, your current one may charge to remove its mortgage from the title.
- Other lender fees: some lenders charge administration or reinvestment fees, and you may have to repay part of any cash-back you received.
Ask for a written breakdown before you commit. Some lenders cover legal or appraisal costs to win the business, especially at renewal.
Worked example: consolidating debt
Alex and Sam’s home is appraised at $750,000. They owe $400,000 on a 5-year fixed mortgage at 4.99%, with 24 months left in the term and 20 years left on the amortization. Their payment is $2,626.34 a month. They also have $80,000 of car loans and credit card and line of credit balances, costing about $2,300 a month in minimum payments.
How much can they borrow? 80% of $750,000 is $600,000, so there’s up to $200,000 of room above their current balance.
The costs. Their lender’s comparison rate for a 2-year term is 4.09%, so the IRD is $400,000 × 0.90% × 2 years = $7,200, higher than three months’ interest ($4,990). They budget about $1,800 for legal and appraisal costs. Your lender’s IRD method may differ and can give a higher number.
| New mortgage | Amount |
|---|---|
| Pay off current mortgage | $400,000 |
| Pay off other debts | $80,000 |
| Prepayment penalty | $7,200 |
| Legal and appraisal (estimate) | $1,800 |
| Total | $489,000 (65% of value) |
At a new 5-year rate of 4.49%, keeping the same 20 years, the payment is $3,080.10. Before, they paid $2,626.34 + about $2,300 = $4,926 a month. They now pay about $1,846 less each month. If they stretched the amortization to 25 years, the payment would be $2,703.76, but they would pay much more interest over time.
The catch. Debt that would have been gone in a few years is now spread over 20. If Alex and Sam spend the monthly saving, a car loan that would have been paid off in three years ends up costing them interest for decades. The refinance pays off best when they keep paying roughly what they paid before and send the difference to the mortgage as prepayments. Model it with the prepayment calculator.
When refinancing makes sense
- Replacing high-interest debt, such as credit cards, with mortgage-rate debt, as long as you don’t run the cards back up.
- Funding renovations that add value or are necessary repairs.
- Near the end of your term, when the penalty is small. Refinancing at maturity avoids the penalty entirely, so if renewal is a few months away, it may pay to wait.
- When rates have dropped a lot, if the interest saved over the rest of your term clearly exceeds the penalty and fees.
When it doesn’t
- When the penalty is large and you’re early in a fixed term. Compare a blend-and-extend or a second product with your current lender first.
- When you only need a small amount for a short time. A personal line of credit may cost less than the fees.
- When you’d stretch the amortization just to lower the payment without a plan to pay it back faster.
Alternatives
A standalone HELOC lets you borrow only what you need, when you need it, up to 65% of the home’s value. Some lenders also offer a blended refinance that adds new money at today’s rate and blends it with your existing rate, which can avoid the penalty. Ask your lender which options they offer and what each costs.
Sources: FCAC, borrowing against home equity; FCAC, preparing to get a mortgage (stress test on refinancing); FCAC, breaking your mortgage contract; FCAC, prepayment penalties; OSFI, minimum qualifying rate; OSFI, real estate secured lending under Guideline B-20 (65% HELOC limit).