Refinancing to Lower Your Rate: When Is It Truly Worthwhile?
Falling interest rates are often the trigger that prompts Quebec homeowners to consider mortgage refinancing. The appeal of a lower rate can seem irresistible, especially when the gap between the current contractual rate and available market rates is significant. However, breaking a mortgage before term involves substantial costs, and the profitability of the transaction depends entirely on the break-even calculation.
The Break-Even Calculation: The Key to Your Decision
The break-even point represents the number of months needed for interest savings achieved through the new rate to offset all refinancing costs. The basic formula is straightforward: divide the total refinancing cost by the net monthly savings. For example, if a borrower has a $300,000 balance at 5.50% and can obtain a rate of 4.25%, the monthly interest savings is approximately $312. If the break penalty and fees total $8,500, the break-even point is approximately 27 months. If the new term is 5 years (60 months), the borrower will benefit from 33 months of net savings after reaching break-even.
Understanding the Prepayment Penalty
In Canada, for a fixed-rate mortgage, the penalty is the greater of three months' interest and the interest rate differential (IRD). The IRD compares your contractual rate to the lender's current rate for a term equivalent to the remaining duration of your contract. The larger the spread and the more months remaining on the term, the higher the IRD penalty will be. For a variable-rate mortgage, the penalty is almost always limited to three months' interest, making it generally much less costly.
- Interest Rate Differential (IRD)
- A mortgage penalty calculation method that represents the difference between the borrower's contractual rate and the lender's current rate for a term matching the remaining contract duration, applied to the balance and multiplied by the number of months remaining on the term. It is generally the method that produces the highest penalty on a fixed-rate mortgage.
Complete Costs to Consider in Quebec
- Prepayment penalty: the most significant cost, potentially representing thousands or even tens of thousands of dollars on a fixed-rate mortgage.
- Notary fees: in Quebec, the CCQ requires a notary for any immovable hypothec. Budget $1,000 to $2,000 for the refinancing deed.
- Appraisal fees: the new lender will often require a professional property appraisal, costing $300 to $500.
- Discharge or release fees: if you are switching lenders, the current mortgage must be discharged from the Quebec Land Registry. These additional notary fees range from $400 to $800.
- Application or administration fees: some lenders charge processing fees, though many absorb them to attract new clients.
When Refinancing Makes Sense
- Sufficient rate spread: A spread of at least 0.75% to 1.00% between your current rate and the new rate generally provides enough margin to offset costs, especially if the mortgage balance is high ($200,000 and above).
- Long remaining term duration: The more months remaining on the current term, the higher the IRD penalty will be, but also the more time you will have to recoup refinancing costs on the new term. Ideally, at least 24 to 36 months should remain for refinancing to make sense.
- Significant mortgage balance: A $300,000 balance with a 1% spread generates $3,000 per year in interest savings, while a $150,000 balance with the same spread generates only $1,500. The balance amplifies the impact of the rate spread.
- Loan-to-value ratio verification: OSFI requires a maximum loan-to-value ratio of 80% for refinancing. Ensure your property has sufficient value to meet this threshold before initiating the process.
Practical Advice for Quebec Borrowers
Before contacting your AMF-certified mortgage broker, gather the following information: your recent mortgage statement showing the balance, rate, and term maturity date, as well as a penalty statement from your current lender. Your broker can then perform a precise break-even analysis factoring in all costs. Keep in mind that the penalty can vary from day to day, as it depends on the declining balance and prevailing rates. Under the LDPSF, your broker is obligated to present a complete and transparent analysis of the refinancing profitability.