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Key takeaways:
Life can change quickly, so it's important to make sure your financial plan is ready for whatever happens next.
Building an emergency savings fund is one way to protect yourself and add more flexibility to your budget. But it's often tough to set aside enough rainy-day funds to cover life's biggest expenses – both the expected and unexpected.
Some people turn to credit cards when they have big or unplanned expenses, but credit card debt is expensive and can put you at risk of accumulating more debt than you can afford.
So, what else can you do when you’re trying to plan for the future and simplify your expenses?
If you own your home and have equity in it, one option is to refinance your mortgage so you have more spending power available.
Depending on the option you choose, a mortgage refinance can add crucial breathing room to your budget. For example, refinancing your debt with a longer repayment period will cost you more interest in the long run, but it may also lower your monthly payment amount and improve your monthly cash flow.
If your goal is to pay down your debt, using a mortgage refinance can also help consolidate your debt. Instead of having to cover a mortgage, auto payment, credit card bills and more, you can use the refinance to add your other debt to your mortgage and consolidate those payments into one mortgage payment. With only one debt to worry about, you can dedicate any extra money you save through refinancing to meeting your financial goals, like contributing to your RRSP or starting an emergency fund. It’s important to consider all associated fees with refinancing your mortgage (including any prepayment charges if you end your existing mortgage term early) so you're confident you're making the right financial decision.
Another way you can explore changing your mortgage is to apply for a combined loan program, a mortgage option which most major lenders offer. A combined loan program helps customers set up multiple mortgage solutions, including home equity lines of credit, providing access to home equity as mortgage balances are repaid. The payment flexibility of a home equity line of credit makes this a powerful tool for building flexibility into your budget — especially if there's a significant gap between your remaining mortgage balance and the current value of your home. In many cases, the interest rate on a home equity line of credit is lower than unsecured credit cards or loans because it is backed by collateral — your home.
Scotiabank's combined loan program is the Scotia Total Equity Plan (STEP). The STEP offers you the ability to take advantage of a variety of credit solutions that cater to your needs. For example, setting up multiple mortgage solutions with varying term and rate structures is a great way to manage interest rate risk.
Unlike a one-time loan that's based on your current financial situation, the Scotia Total Equity Plan (STEP) grows with you over time, increasing your borrowing power in line with your home's equity.
You'll be able to keep accessing money through your STEP as long as your account is open and in good standing. You also can easily add multiple products under the STEP within your borrowing limit without having to re-qualify for additional credit and remove products as your needs change over the years. Think of it as a borrowing solution that allows you to consolidate your debts to help lower your overall borrowing costs.
Learn how you can save by using the Scotia Total Equity Plan Calculator.
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When you apply for a mortgage refinance, you're able change your current mortgage loan for more favourable terms — this can include extending the term of repayment, which might lower your monthly mortgage payment. Another option when you refinance is that you could keep your current mortgage terms and use your home's equity to open a line of credit or finance an additional mortgage as with STEP. For example, if you added a new mortgage as part of your STEP, you could fund a vacation home or investment property without changing your existing mortgage terms.
The mortgage refinance process is similar to what happens when you complete a credit application. You'll need to complete a mortgage stress test and verification of income and/or employment to qualify. The financial institution will also order an appraisal on your property to see how much equity you've built up. Some refinances will also require additional legal documentation.
For many homeowners, a mortgage refinance may put them in a better financial situation. However, it's not the best option for everyone, so let’s look at the pros and cons carefully.
Pros
- Debt consolidation: With a cash-out refinance, you can take out cash to pay off other high-interest debts. This process allows you to consolidate your debts into one single payment, which can help simplify your budget and potentially pay down your debt faster through one payment at a secured interest rate. In most cases, you may have a lower interest rate through your new mortgage than you had when you were paying your different debts separately.
- Possible lower rates: Compare your rate to the current market rates. If your rate is higher, there may be the potential to lower your rate, especially if you've improved your credit score since first applying for your mortgage.
- New loan terms: Refinancing can allow you to change the term and amortization period of your existing mortgage.
Your amortization period is the actual number of years (mortgage length) it will take to repay a mortgage loan in full. This may go beyond the term of the mortgage contract. For example, mortgages often have five-year terms but 25-year amortization periods.
If you'd like to pay off your mortgage faster, you could potentially do this by refinancing to a 15-year amortization period, or switch to a 30-year amortization period to reduce your monthly payments.
Cons
- Refinancing costs: There are fees involved in refinancing your mortgage. These fees may include property appraisal fees, title search fees and legal fees. You can use a mortgage calculator to help you calculate whether the potential savings from a lower interest rate or different amortization period will outweigh these costs over time.
- Possible prepayment charge: You may have to pay a prepayment charge or discharge fees when you refinance your mortgage. A prepayment charge is a fee charged by the lender when the borrower pays off all or a portion of a mortgage more quickly than provided for in the mortgage agreement. Discharge fees are fees that happen while removing the current registration of the mortgage when you are refinancing.
Mortgage rates may change frequently and are influenced by several factors, including the Bank of Canada's interest rates, the health of the Canadian economy and global economic trends. While you can't control current interest rates, you can keep your credit score in check so you always get the best rate possible for your financial situation.
Additionally, using a financial institution that you have a strong relationship with or are looking to have a stronger relationship with can give you access to lower interest rates and flexible borrowing options, along with access to special programs. It's also a good idea to keep an eye on current mortgage rates and take advantage of your mortgage lender’s rate hold policy. This lets you secure your interest rate at the beginning of your refinance process in case rates change.
Every mortgage has a maturity date, which is the last day of the term of your mortgage agreement. At that point, you will need to decide whether you want to renew your mortgage with your lender, refinance your mortgage or pay your mortgage balance in full.
A mortgage renewal is when you extend a mortgage agreement with your lender for another term. The length of the term and the conditions (such as the rate of interest) may change. The new interest rate, payment frequency and remaining amortization will be used to decide your new payment amount. The amortization period and mortgage amount stay the same.
You may want to renew your mortgage early. One potential advantage of renewing early rather than waiting until the renewal period is that you may be able to secure a lower interest rate right away vs. waiting for your maturity date if current rates are favourable. Your lender may allow you to lock in a current rate for future renewal, protecting you from potential rate increases in the meantime. For example, Scotiabank's 180-day early renewal option allows you to renew early without a prepayment charge.3
A mortgage refinance is the process of replacing an existing mortgage with a new one, either with the same lender or a different one. You may decide to refinance in order to get better terms for your mortgage, such as a lower interest rate, smaller monthly payments or to shorten or increase the repayment period (amortization) to one that better fits your financial goals.
You might also want to do a refinance to get funds using your home’s equity. With the STEP program, when you are refinancing, you can look to unlock more equity in your home by potentially increasing your STEP limit and potentially look at other borrowing solutions to add, like a secured line of credit or a second mortgage.
Mortgage refinance requirements will be different depending on the mortgage lender. But most lenders require the following:
- A minimum credit score: Your lender will set a minimum credit score for mortgage applicants. A higher credit score signifies that your application is lower risk.
- Income requirements: Lenders will also look at your income to make sure you have the means to repay the loan. This might involve providing proof of income, including recent pay stubs, employment verification and past tax paperwork.
- A healthy loan-to-value (LTV) ratio: Your LTV ratio shows how much equity you have in your property and is calculated by dividing the current loan balance by the new appraised value of your home. The maximum LTV for a refinance is 80%; so when you are refinancing, you can only refinance up to 80% of your property’s new appraised value.
- A low total debt service ratio (TDSR) ratio: Your TDSR ratio, which is the percentage of your monthly income that goes toward paying off all debts, is another important factor. A lower TDSR indicates a better balance between debt and income, assuring the lender that you can more easily manage your monthly expenses.
When you are looking at your financing options with your home, you might consider a home equity line of credit (HELOC). A HELOC allows you to leverage the equity in your home to secure a revolving line of credit. This can be particularly beneficial in a competitive housing market, as it provides access to funds without requiring you to sell or move from your home.
The borrowing limit for a HELOC is typically determined by the value of your home's equity, which is the difference between the current market value of your home and the amount you still owe on your mortgage.4 As you pay down your mortgage or if your home's value increases, your equity — and potentially your credit line — grows.
Since a HELOC is secured against your home, lenders often view it as less risky than unsecured loans. As a result, the interest rates for a HELOC are generally lower than those for personal loans or credit cards, making it a more cost-effective borrowing option for large expenses.
Depending on how you choose to receive your funds (all at once or over time), your loan may be considered a home equity term loan or a home equity line of credit (HELOC).
Deciding between these two loan options often comes down to the solution that works best for you. If you have a significant upcoming expense, such as a roof repair or a college tuition, a home equity term loan will give you the cash you need in one lump sum.
But if you don't have an immediate expense, you may want to consider applying for a home equity line of credit instead.
Similar to a credit card, a home equity line of credit — which at Scotiabank – the option is the ScotiaLine Personal Line of Credit (with or without access card), — which will give you access to funds that you can borrow for expenses as they come up. You'll only be charged interest on the amount of credit you use so you can avoid spending money on debt you don't need.
Whether you want to pay off debt faster through consolidating your unsecured debt under a more favorable mortgage rate or you want to use your equity to finance your dream vacation home, Scotiabank can help.
