According to Benjamin Tal, Senior Economist at CIBC World Markets, Canadians' debt-to-income ratio reached an all-time high in 2004. Fortunately, this isn't as bad as it sounds because while incomes have remained relatively flat and debt has risen, Canadians' assets have been rising too--thanks in large part to rising real estate prices. And this has created a way for consumers to manage their increasing debt loads more affordably.
Refinancing mortgages to pay off debt has become extremely common. With house prices increasing and mortgage rates at historic lows, people are realizing they have a lot of equity sitting in their homes. At the same time, they're making comparatively high interest payments on car loans, lines of credit and credit cards. So refinancing allows them to pay off their high interest debt with the much lower rates of a mortgage.
How much lower? Today, consumer loans are fluctuating anywhere from Prime plus 2% to Prime plus 5%. With Prime currently at 4.25%, that means you'd be paying anywhere from 6.25-9.25%. Credit card interest rates range from a low of about 9% right up to 18-19%. And if it's a store credit card, it can be even higher. Now compare those rates to today's typical variable rate mortgage, which is currently at 3.5% (Prime minus .75%). You can even lock in for five years at about 4.5%, or 10 years for around 5%!
Credit card interest rates range from a low of about 9% right up to 18-19%.
Typically, the best time to refinance your mortgage for debt repayment is when it's coming due or you're selling one house and buying another. But depending on your situation, you may also save by breaking out of an existing mortgage.
As your Mortgage Centre Specialist, I can do the math and show you how much you're going to save regardless of which route you choose. But just as important, I can also provide valuable advice about managing debt more effectively.
The goal of refinancing should be to save interest and get out of debt faster. That usually means increasing your mortgage payments to reflect the new amount you've added to the mortgage. Another consideration is what the debt is for. If it's for investment purposes such as paying off a renovation loan and a mortgage on a second property, then you're not really incurring more debt. But if you're refinancing to pay off car loans and ongoing credit card purchases, it's important to understand that you're going to have to change your spending habits or you'll be refinancing again before you know it. To help with this process, I like to point out how much refinancing can save you each month and suggest you use these extra funds to start an RRSP, make lump sum payments on your mortgage or establish a saving plan.
The goal of refinancing should be to save interest and get out of debt faster.
But how do you know whether you have enough equity to consider refinancing? Just give me a call! The first question I'll ask is what you think your house is worth and what the assessed value is. From my experience of seeing appraisals on a daily basis and knowing local neighbourhoods, I'll have a pretty good grasp of what your home is worth. So to give you a rough idea of how much equity is available to you, I take your home's market value--say $200,000--and subtract your existing mortgage balance--say $100,000. So that means you have $100,000 of equity. Since you can only refinance up to 75% of the home value without incurring CMHC insurance fees, in this case, you'd have $50,000 available for debt consolidation.
In most cases, refinancing is fast and easy. If you're a wage earner, you need a recent pay stub, your most recent T4 and your latest mortgage statement. If you're self-employed, you need three years of income tax returns and your most recent mortgage statement. If an appraisal is required, it'll cost anywhere from $200 to $250, depending on your local market. Legal fees typically range from $400 to $800. Basically, from start to finish, refinancing can be complete in as little as five business days.
Of course, all these costs are usually more than covered by your interest savings. This can even be true of the penalty for breaking out of an existing mortgage. I'll do a cost benefit analysis. In 95% of cases, it's worth paying the penalty. If not, I'll advise you of the cost and suggest you consider waiting until your mortgage comes up for renewal.
I'll ascertain whether or not refinancing makes sense for you as part of an overall debt management strategy.
Please have a look at the example of refinancing for debt consolidation I've included below. If you're interested in exploring the possibilities in your situation, the first step is to call me. We'll talk about your needs and financial realities, then I'll ascertain whether or not refinancing makes sense for you as part of an overall debt management strategy.
Example of the potential benefits of refinancing for debt repayment.
Current market value of your home:
$200,000
Existing first mortgage at 5.50% (monthly payment $685):
$100,000
Available equity to refinance (can be increased, but CMHC fees will be incurred): $50,000
Car loan at 8% (monthly payment $425):
$15,000
Credit card balance at 18% (minimum monthly payment $240, almost all interest): $8,000
Home needs a new roof and furnace:
$10,000
Unused RRSP contribution room available (you earn $60,000/year and have 20 years until retirement):
$17,000
Total non-mortgage funds required:
$50,000
Current total monthly payments:
$1,350
You take out a new mortgage of $150,000 at a 5-year closed rate of 4.75%. Amortized over 20 years, the new monthly payment is $965 (as an option, change the payment to $483 bi-weekly and the amortization is lowered to 18 years). Total monthly payments have been reduced from $1350 to $965, a saving of $385 per month or $4,620 per year.
If the $17,000 lump sum and $4,620 per year were invested in an RRSP for 20 years, assuming an annual return of 8%, this would produce an RRSP value of $290,000 in 20 years. Assuming a marginal tax rate of 30%, in the first year you'd receive a tax refund of $5,100 from the $17,000 RRSP contribution. Each subsequent year, a $1,380 tax refund would be realized from the $4,620 RRSP contribution. These refunds could be re-invested in RRSPs, or they could be used to pay down the mortgage or fund a vacation.
