Cash-Out Refinance in Canada: How to Unlock Your Home’s Equity
Table of contents
A cash-out refinance, better known as an equity takeout (ETO), allows you to access your home’s equity. You refinance your existing mortgage for a larger amount, using the equity as collateral, and “cash out” the difference. The additional amount you take out in cash is added to your mortgage balance and helps you fund large expenses like home renovations, debt consolidation, or investments.
Key Takeaways
- With a cash-out refinance, you can borrow up to 80% of your home’s value.
- Cash-out refinances often have lower interest rates than personal loans and credit cards.
- Borrowing more can increase your monthly mortgage payments and the time it takes to pay off a higher mortgage completely.
What Is a Cash-Out Refinance in Canada?
A cash-out refinance allows homeowners to replace their current mortgage with a new one for a larger mortgage, giving them access to a lump sum of cash. The amount you can borrow is based on the equity you’ve built in your home and can be used for home improvements, debt repayment, or investments.
A standard refinance involves replacing your mortgage for a lower interest rate, a longer amortization, or adding/removing a co-signer (release of covenant). A cash-out refinance consists of borrowing more than your mortgage’s remaining balance. The difference between your new mortgage amount and your current balance will be paid out to you in cash.
How Does a Cash-Out Refinance Work?
A cash-out refinance works by refinancing your mortgage for a higher amount, essentially replacing your current mortgage with a larger amount, taking advantage of the equity you have built.
- Refinance your existing mortgage: You take out a new mortgage that replaces your current one.
- Borrow additional funds: The new mortgage balance will be higher than your existing one, giving you access to the equity you’ve built in your home.
- Receive the cash difference: The extra amount you borrow is provided in a lump sum, which you can use for various expenses.
For example, if your home is valued at $600,000 and you still owe $300,000 on your mortgage, you have 50% equity. With a cash-out refinance, you can borrow up to 80% of your home’s value, which would be $480,000. After paying off the remaining $300,000 plus any fees, penalties and charges as part of the refinance transaction on your mortgage, you would receive approximately $180,000 in cash.
How Much Can You Cash Out with a Cash-Out Refinance?
The maximum loan-to-value (LTV) ratio for a cash-out refinance in Canada is 80% on a term loan mortgage or up to 65% if solely on a HELOC. This means you can borrow up to 80% of your home’s value minus the outstanding balance on your current mortgage. Your loan amount depends on your home’s appraised value, your remaining mortgage balance, and your lender’s qualification criteria.
Example Calculation:
- Home value: $500,000
- Current mortgage balance: $300,000
- Maximum LTV (80% of home value): $400,000
- Cash available: $400,000 – $300,000 = $100,000
This allows you to refinance your mortgage for $400,000, with $100,000 received in cash.
Cash-Out Refinance vs. Standard Refinance
A standard refinance involves replacing your existing mortgage with a new one to take advantage of a lower interest rate, extend the amortization, or add or remove a co-borrower. However, a cash-out refinance allows you to borrow more than what’s left on your current mortgage, giving you access to the equity you’ve built up in your home.
- Cash-Out Refinance: This increases your mortgage balance and provides a lump sum of cash, net of any debt consolidation or other payouts.
- Regular Refinance: You will only replace your existing mortgage with a new one for the same amount.
Pros and Cons of Cash-Out Refinance
Pros
- Borrow a Larger Amount: You can access a significant amount of money (up to 80% of your home’s value) compared to other loan options.
- Lower Interest Rates: Since a mortgage is a secured loan (or HELOC), cash-out refinance rates are generally lower than unsecured personal loans, unsecured lines of credit or credit cards.
- Consolidate Debt: You can use the lump sum to pay off high-interest debt, saving you money in the long run.
- Tax-Free Cash: The cash you receive from a cash-out refinance is considered debt, so it will not be considered income, making it tax-free.
Cons
- Increased Mortgage Balance: Borrowing more will increase your mortgage balance, which can lead to higher monthly payments.
- Higher Interest Payments Over Time: If you extend the amortization period to lower your mortgage payments, you may pay more interest over the life of the loan.
- Longevity of Repayments: The higher loan amount could substantially increase the time it takes to become mortgage-free.
- Risk of Foreclosure: If you cannot keep up with the higher mortgage payments, your home could be at risk of foreclosure.
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What Can You Use a Cash-Out Refinance For?
There are several ways you can use the cash you receive from a cash-out refinance, including:
- Home Improvements: Investing in renovations can increase your home’s value, potentially boosting your equity even further.
- Debt Consolidation: Pay off high-interest debt, such as lines of credit, credit cards, or personal/consumer loans, by consolidating them into a lower-interest mortgage.
- Investments: Some homeowners use the funds to invest in a business or the stock market, meet their annual limit for their RRSP contribution to reduce their taxable income, or even downpayment on a second property.
- Education Costs: A cash-out refinance can be a way to cover significant expenses, such as paying for your child’s education.
Alternatives to Cash-Out Refinance
While a cash-out refinance can be a great way to unlock the value of your home’s equity, it’s not always the best or only option. Some alternatives could be more suitable or flexible depending on your financial needs. Options like a Home Equity Line of Credit (HELOC), a home equity loan, or even a reverse mortgage can provide access to your home’s equity with different repayment terms and conditions.
Reverse Mortgage: Available to Canadians over 55, a reverse mortgage allows you to access your home’s equity without making monthly mortgage payments, ideal for retirees.
Home Equity Line of Credit (HELOC): A HELOC functions like a credit card, allowing you to borrow against your home’s equity as needed. You only pay interest on the amount you use.
Home Equity Loan: This second mortgage lets you borrow a lump sum based on your home’s equity without replacing your existing mortgage.
Frequently Asked Questions
How much can I cash out with a cash-out refinance in Canada?
You can cash out up to 80% of your home’s appraised value minus the current mortgage balance. Canadian lenders set this limit to ensure homeowners maintain some equity in their property. For example, if your home is valued at $500,000 and you owe $300,000 on your current mortgage, you can refinance up to $400,000 (80% of $500,000). This would allow you to withdraw $100,000 in cash after covering your existing mortgage balance, penalties, legal costs, and discharge fees.
Are there penalties for cash-out refinance before my mortgage term ends?
If you refinance before your mortgage term ends, you may incur prepayment penalties. These penalties compensate the lender for the loss of interest payments they would have received had you completed your term.
For a fixed mortgage, the penalty is calculated based on the greater of 3 months of interest or the interest rate differential (IRD). For a variable mortgage, the penalty is typically three months’ interest. The specific penalty amount will depend on the terms outlined in your mortgage contract. Consult with your lender to determine any penalties before moving forward with a cash-out refinance.
Can I get a cash-out refinance with bad credit?
Getting a cash-out refinance with bad credit is possible but may be more challenging. Most traditional lenders prefer borrowers with good credit scores because they represent a lower risk. If your credit is poor, you may need to work with alternative lenders who specialize in helping individuals with lower credit scores.
However, the terms may be less favourable, and lenders could charge higher interest rates and fees to offset the added risk and their costs. Additionally, you might not be able to borrow as much of your home’s equity as someone with a better credit score.
Is a home appraisal required for a cash-out refinance?
Yes, a home appraisal is typically required for a cash-out refinance. The appraisal determines the current market value of your property, which is essential for the lender to calculate how much equity is available to you. The value of your home can fluctuate over time due to changes in the real estate market or improvements made to the property, so an accurate and up-to-date appraisal is necessary. Based on this appraisal, lenders will calculate the maximum amount of money you can borrow through the refinance.
Will my monthly mortgage payments increase with a cash-out refinance?
Yes, in most cases, a cash-out refinance will increase your monthly mortgage payments. Since you’re borrowing more money, your mortgage balance increases. Your monthly payments will likely rise unless you extend the amortization period to keep payments lower, though this may still result in paying more interest over time. The size of the payment increase will depend on factors like the total loan amount, interest rate, and amortization.
Final Thoughts
A cash-out refinance can allow you to leverage your home equity for various purposes like debt consolidation, fund education expenses, renovating or investing. However, it’s important to carefully weigh the pros and cons, consider your financial goals, and explore alternatives before deciding which mortgage solution is right for you. Work with a trusted mortgage professional to understand the potential risks and benefits of cash-out refinancing.Are you looking to access your home’s equity? Contact nesto’s mortgage experts to find the best mortgage solution for your financial goals.
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