by Corben Grant on 24 May 2022
What's the difference and which one is right for you?
When applying for a mortgage, buyers have to make a lot of decisions about exactly what sort of agreement they want to reach with their lender. It’s an important step in the process and can take some time to complete, but after all that work, you can happily live in your home while you work down your principal with mortgage payments.
That is, until your term ends or you decide you want to alter your mortgage terms. Though you may be set to pay your mortgage for 25 years, a lot can change in that time when it comes to your mortgage terms. This is a good thing for Canadians because it offers the ability for your mortgage to be adjusted as your own life circumstances change over the course of your amortization period. It also offers a lot of opportunities to negotiate better terms and take advantage of your increasing home equity.
There are two major ways that Canadians can alter their mortgage contracts. The first is a mortgage renewal and the other is a mortgage refinancing. These two distinct options have their own benefits and limitations and it’s important to know what your options are. This is particularly important in our current market where home values are higher and interest rates are beginning to rise.
Many Canadians are looking to renew or refinance to get in on the best terms while they last. But, if you don't know the difference, you won’t be able to make a renewal or refinance work to your advantage. In this article, we will help to explain the difference between renewal and refinance, why these options exist, and how to know which is right for you.
What is a mortgage renewal?
When you take on a mortgage, there are two crucial time periods to keep in mind. The first is your amortization period, which is essentially how long you have to pay back the full loan. The other is the term length. The term length represents how long you are able to wait between mortgage renewals. Almost every Canadian mortgage will be renewed multiple times over the course of its life.
On the most basic level, a renewal is simply signing a new contract to continue your current mortgage for another term, usually with an updated interest rate to reflect the current market. Your lender may even allow you to renew automatically with little fuss.
If you are happy with your mortgage and its terms, there is nothing wrong with simply renewing and keeping things mostly the same, however, you can also take advantage of your renewal opportunity to change some things up. Remember that renewal is ultimately a negotiation between you and your lender, so you won't necessarily be able to get everything you want.
The biggest reason to negotiate during your renewal is to achieve a better interest rate. Your bank may be willing to give you a lower rate, but they won't always give it to you upfront so you may need to ask for it.
Furthermore, if you are really set on a better rate, you may have the option to transfer your mortgage to a new lender. Your new lender will work with your previous lender to cover the mortgage and essentially take on your debt themselves. Switching lenders can give you access to better rates and may offer other positives if the new lender is preferable in areas like customer services and account benefits.
Overall, a renewal is a standard part of a mortgage, but it also offers you a chance to change things up if you see fit. Either talking to your lender or consulting with a mortgage advisor can help you to better understand what options are available for your particular circumstances.
Why do we need to renew mortgages?
While mortgage renewals may seem like a chore, they really do benefit both the lender and the borrower. Mortgages can last for a very long time and a lot can change in the 25-30-year period that you’re paying your mortgage. For example, you may find yourself making more money and want to adjust your mortgage accordingly. Or, maybe you are unhappy with your lender and want to pursue other options. On the other hand, your lender needs to adjust to market conditions to make sure their mortgage loans remain viable. By allowing renewals, it prevents either side from being locked into a decades-long contract that could become untenable over time.
What is mortgage refinancing?
Refinancing is often seen as a similar thing to renewals, but they are very different processes with their own uses.
Essentially, a refinance involves completely breaking off your current contract and replacing it with a brand new one. This new loan, either from the same lender or a new one, is used to pay off the remaining amount on your current loan in order to end the previous contract. The new loan can have entirely different terms as it is, in essence, a brand new contract. This can offer numerous benefits for a homeowner.
Renegotiate mortgage terms
When refinancing, you have a lot more flexibility than with a renewal. Since you are negotiating a brand new mortgage, almost all aspects of the loan will be on the table for changes. This can allow you to completely readjust your mortgage to better fit your needs and potentially access even better terms that were unavailable in a renewal.
Oftentimes, people will choose to refinance in order to lock in a lower interest rate, switch between a variable and fixed-rate mortgage, or make lower monthly payments. You also have the option to refinance at any time rather than waiting for your mortgage term to end.
Access home equity
Refinancing can also allow you to access your home equity to borrow more money. As you pay off your mortgage, you grow your home equity which also increases as your home goes up in value. You can borrow up to 80% of your home's value when refinancing your mortgage. This means you can borrow the full amount and collect the difference to access your home equity. The reason banks allow for more money to be borrowed on a refinance is your increased leverage serves as collateral to the larger loan.
For example, if your mortgage had 30% of your home's value remaining, you could refinance for 80% of the value, pay off 30%, and keep the remaining 50%, which you can use now and pay back over time. This can be a great way to access a lump sum of your home equity without selling. Money borrowed from a refinance can go towards whatever you like such as investments or home improvements.
Another benefit of borrowing more money in a refinance is that it can allow you to consolidate debt. If you have high-interest debts such as credit card debt or auto loans, you could refinance your home, using some of the money to pay off your higher-interest debts and consolidating them under a lower interest rate, saving you money in the long run.
Downsides of a refinance
Refinancing can also have its own downsides as well. Notably, your current lender may charge a hefty fee for ending your mortgage early which can eat into the financial benefits of refinancing. In addition, you will be starting a new loan all over again which means starting at the beginning of a new amortization period. While you may have negotiated lower payments, you may now be paying for a longer period. You will also need to go through all the qualifying steps required for your first mortgage including proving income, debts, and assets, passing the mortgage stress test, and more.
When to refinance or renew
Deciding when to refinance or renew will depend a lot on your current situation and what you want to get out of the process.
Renewals are a simpler option
Renewals are a good option if you want to keep things simple. If you are happy with your mortgage terms and the interest rates being offered and don't need to access your home equity yet, renewing will be a simple choice and will not require too much work on your part. If you aren't happy with your mortgage purely because of the rates, it may also be worth waiting for your renewal and then negotiating or shopping around with other lenders.
One big thing to consider is if your mortgage has completed its term. If you are still in the middle of your mortgage term, renewal is likely not an option for you and you would need to wait or refinance if you want to adjust your mortgage.
Refinance for better mortgage terms
You will also need to refinance if you want to adjust anything other than your mortgage interest rate. Though it may cost more and require a longer process, the benefits can outweigh the costs if done correctly.
Refinancing is also your best option if you own a lot of home equity that you would like to access all at once. For example, if you wanted to do renovations or put the money towards a second property, this is a great option. If you don’t need it all at once, you may choose instead to opt for a HELOC.
Which option offers better mortgage interest rates?
Finally, renewing or refinancing is often used to access better interest rates. Overall, both can provide you with a better interest rate than your current one, though as for which option is better, it will depend on a number of factors unique to your situation as well as the current state of interest rates.
Overall, the most important thing you can do when it comes to comparing a mortgage renewal vs. refinancing is to understand your options. Be it a refinance or renewal, you will be locked into whatever decision you make for a good number of years so you need to be careful before you make any decisions, especially if you are choosing to refinance, you need to seriously consider the financial pros and cons and the long-term implications of this decision. When in doubt, always consult your lender or mortgage broker who can help you navigate which options are best for you.