Should you refinance your existing mortgage to buy an investment property?
Get to grips with the pros and cons before you refinance your mortgage.
There are numerous opportunities when it comes to handling your home equity, but none are as exciting as refinancing your mortgage. After all, refinancing allows you to invest in another property—a hugely rewarding venture. However, you need to be aware of factors that determine whether refinancing is the best route for you.
Refinancing your mortgage means renegotiating the mortgage on your current home to create a new plan. Knowing whether to refinance your mortgage to buy a second property is a huge decision. But with the right information at your fingertips, you’ll be ready to make informed decisions and fulfil your housing dreams.
What Is Home Equity?
Home equity is the difference between your home’s current value and the amount that you owe against the property. In effect, home equity is the portion of your property that you actually own. Lenders will allow you to loan against your share—you can invest these funds in additional property.
Why Refinance Your Mortgage?
There are many reasons why you may choose to refinance your mortgage. Perhaps you want to pay off debt, remodel your home, enjoy lower rates or switch mortgage providers. Whatever your reason, refinancing your mortgage can be a great source of extra capital.
When you refinance your mortgage, you’ll be able to access your home equity to any value that doesn’t exceed the 80% loan-to-value threshold. Put simply, you can’t owe your lender more than 80% of your home’s value at the time of refinancing.
You can use your home equity to buy a recreational property, invest in the stock market, pay off debt or buy out a co-owner. The options are endless. Keep in mind, though, that your lender will want to know why you’re refinancing. They’ll also want to know what you plan to do with the funds.
Refinancing your mortgage can lead to long-term gain and appreciation. Keep your investment and/or recreational properties for five to seven years, and your equity is likely to appreciate. Better yet, rental tenants can pay your interest and at least some of your property’s operating costs.
How Much Does It Cost to Refinance Your Mortgage?
Refinancing your mortgage is only a good idea if investing your home equity elsewhere is a financially viable option. Consider whether you plan to break the mortgage term early or refinance at the end of the term. You also need to consider whether you’ll need to leave your lender.
These decisions will dictate the costs that you will be responsible for. For example, you may incur a mortgage prepayment penalty, mortgage discharge fee, mortgage registration fee and legal fee. Legal fees apply to both standard mortgages and collateral mortgages. You may also incur penalties of three months’ interest or up to five percent of the mortgage balance.
As the Canada Mortgage and Housing Corporation no longer insures refinances, refinancing incurs higher interest rates. However, taking your amortization to thirty years may result in lower monthly payments despite the higher interest rate.
What Should You Consider Before You Refinance Your Mortgage?
As with any loan, you shouldn’t accept funds just because a lender offers them. Spend time completing a detailed financial cost-benefit analysis to calculate whether refinancing will benefit you. Drawing up a cost-benefit analysis is especially important if you’re planning to buy a second property or pay off debt.
Ask yourself these questions before deciding to refinance your mortgage.
- Will your income comfortably cover the higher mortgage payments on the primary home both now and in the future?
- Will your cash flow cover mortgage payments, operating costs and unexpected repairs/maintenance on the second property?
- Do you have sufficient savings to rely on in the unexpected case of having to take time off work?
- Do you have the skills and time to manage tenants, service providers and the investment property’s finances?
- If you decide to sell the second property, will it maintain its value and will you be able to sell it in your expected timeframe?
It’s vital that you consider these questions and the impact that your answers could have should you refinance. Imagine a mortgage-free couple on the brink of retirement who decide to refinance their mortgage (0% loan to value). Once they have paid for their living expenses and higher mortgage on their primary residence, their remaining funds may be too low to live on. Have you thought about every situation that could affect you financially?
So, now you know the pros and cons of refinancing your mortgage. You’re ready to take your next steps. If you’re confident that refinancing your mortgage is a good option for you, it’s time to hire a savvy mortgage professional.
Crunch the numbers and be brutally honest with yourself about your finances, skills, experience and risk factors. Refinancing your mortgage to invest in a second home is a great financial move if you do it right.
Book a call with a mortgage specialist to get tailored advice on refinancing your mortgage.
- Government of Canada. “Borrowing Against Home Equity.” https://www.canada.ca/en/financial-consumer-agency/services/mortgages/borrow-home-equity.html
- Ratehub. “Mortgage Refinance.” https://www.ratehub.ca/mortgage-refinance