“Should we refinance our mortgage?”

• Mortgage principal: $572,000
• Weekly payments: $746.00
• Interest rate: 3.78% fixed and locked in until December 2024
• Penalty fee for breaking mortgage: $33,000

If we decide to pay the penalty, we could lock into a four-year mortgage at 1.74% fixed, which looks like it would save us approximately $2,500 to $3,000 in interest payments.

Here’s where I think it gets interesting. If we decide to continue paying the same $750 per week that we do now and put the extra money towards principal, the difference between that and the new weekly mortgage payment of $570 would be $175—giving us $8,400 per year to put directly towards principal. Over four years, that should allow us to reduce our principal by $33,600. 

It seems we should consider breaking our mortgage to take advantage of the lower rate. Are we right?

—Jill and Bob

Before we get into the specifics of your situation, let’s look at what refinancing a mortgage entails and what it may end up costing you. 

What does it mean to refinance a mortgage?

A mortgage refinance is when you change the terms of your mortgage contract. Common reasons for choosing this option include:

• Getting a better interest rate
• Borrowing more to consolidate debt or to purchase another property
• Extending the amortization to lower your payments 

Refinancing to a better rate can help reduce your monthly payments, free up cash flow or—if you maintain your current payment amount—pay off your mortgage faster. 

Note that a mortgage refinance is different from a mortgage renewal. A mortgage renewal occurs when the term of your mortgage has ended and then renews into a new term. Prior to your term renewal, your lender will send you a renewal offer with a proposed mortgage rate which you can either accept or negotiate. This cycle of renewals keeps repeating until you have reached the end of your amortization and you own your home. 

Back to refinancing… There are a number of things to watch out for when deciding whether or not to refinance: 

• You may face a penalty for breaking your mortgage, which may be more than the cost savings provided by a lower rate. You will either be charged three months’ interest or an interest rate differential (calculated based on the difference between your current rate and what the lender could charge today). Also, all penalties are not the same. A mortgage pro can help you calculate the penalty.
• You will have to re-qualify for the mortgage, which means re-confirming your income and having a credit check done. In some instances, you may have trouble re-qualifying for the same mortgage using current qualification standards.
• You will have your home reappraised to determine its current value, which can run you around $500.
• It’s unpredictable where interest rates end up in the next few years. It is possible that rates will be even lower then. 
• You may not have the option to refinance. As, some mortgage contracts have a “sale only clause,” meaning the provider does not permit refinancing, and the only way out of the mortgage is to sell your home.

Andrea Urban, a mortgage broker with Premier Mortgage in Toronto, suggests you consider refinancing when current rates are lower than your existing rate and you have at least four months to go before your mortgage term is up.

“Keep your mortgage as flexible as possible, because life happens,” she says, “and recruit a mortgage pro to help you identify those mortgages with the most flexibility.” 

Should you refinance your mortgage? 

Now that you know what to consider before contemplating a refinance, let’s have a closer look at your situation, Jill and Bob. As tempting as it looks, you may be better off sticking with your original mortgage. 

The real question is: What will your mortgage balance be in three years if you reduce your mortgage rate by 2% and add $33,600 to your mortgage? I say three years, because that is when your current term is up, and the rate may change at that time.

Without all of your mortgage information, my figures are slightly different from yours, but I can get close enough that you’ll know which option is right for you. 

Looking at the table below, you’ll see the interest you’ll pay/save and the remaining balance after three years. 

Interestingly, if you pay the penalty and reduce your weekly payment amount, you will save about $33,000 in interest and apply an additional $14,000 or so towards the principal. However, you will still owe more on your mortgage at the end of three years.

In considering this change, is your goal to get your mortgage paid off or to reduce your weekly mortgage payment? If money’s tight and you need to create some breathing room, renegotiating your mortgage may make sense.

In your case, it sounds like your goal is to get your mortgage paid off, and you suggested renegotiating and maintaining your current weekly payments as a strategy to do just that. 

The table above shows that even if you maintain your weekly mortgage payments, your mortgage balance is going to be about the same as if you stick with your current mortgage. Some may argue that you could put your weekly savings toward a tax-free savings account (TFSA) rather than apply it to the mortgage, but that is not a guaranteed return.

Another consideration is the interest rate three years from now when your current mortgage matures. If it is lower than the current rate being offered then that is another possible reason not to renegotiate; however, there is no way to know what the rate will be in three years.

To me it looks like you are best to stick with your current mortgage and not renegotiate for the lower rate. In three years, when it comes time to renew, if you find your weekly payment will be lower, stick to your current weekly payment as you have suggested. 

Allan Norman, M.Sc., CFP, CIM, RWM, is a fee-only certified financial planner with Atlantis Financial Inc. and a fully licensed investment advisor with Aligned Capital Partners Inc. He can be reached at atlantisfinancial.ca or [email protected].

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About Allan Norman, MSc, CFP, CIM

With over 30 years as a financial planner, Allan is an associate portfolio manager at Aligned Capital Partners Inc., where he helps Canadians maintain their lifestyles, without fear of running out of money.

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