Who this is for: Homeowners with a sizeable amount of equity who are weighing a bigger single mortgage against keeping their existing one and adding a second loan.
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When a household needs a large sum and has the equity, there are two obvious roads. You can leave the existing mortgage alone and add a loan behind it, or you can tear it up and write a bigger one. The second road is the equity takeout refinance, and its cost depends less on the new rate than on what you give up to start it.
What an equity takeout refinance is
You end your current mortgage contract early, borrow a larger sum against the home with a new mortgage, pay off the old balance and costs, and keep the rest as cash. The Financial Consumer Agency of Canada says you can usually borrow up to 80% of your home’s value, and that the home acts as security for the equity you borrow.
The new mortgage has one rate, one term and one payment schedule for the whole balance. That tidiness is the appeal. The catch is that the new rate applies to the old balance too, and the old contract may charge a penalty for ending early.
What breaking the old mortgage costs
The agency says that if you break a closed mortgage contract you normally pay a prepayment penalty that can cost thousands of dollars, and that an open mortgage has no penalty. It adds that other costs can include administration, appraisal, reinvestment and discharge fees, and that you may have to repay any cash back you received.
On how the penalty is calculated, the agency says it is usually the higher of three months of interest on the outstanding balance, or the interest rate differential. The differential totals the remaining interest on your term at two rates and takes the difference. The first worked example above shows how a 1.5 point gap over two years turns a $5,000 three-month figure into a $12,000 penalty.
When it can make sense
It can make sense when your current rate is close to or above today’s rates, so breaking costs little and a new rate does not hurt. It also makes sense when the term is ending soon, since waiting until the end of the term avoids the penalty entirely. The agency lists waiting until the end of the term as one way to reduce a large penalty.
It suits a household that wants one payment and a long amortization, where the extra borrowing is modest compared with the whole mortgage. And it suits a bank-qualified borrower who gets a competitive rate on the new loan, because a bank refinance is usually cheaper than a private second.
When it makes things worse
It makes things worse when your old rate is far lower than today’s. You would pay the new, higher rate on the whole balance, not just on the cash you take out. The second worked example shows a case where keeping a cheap first mortgage and adding a costly second still wins by $4,700 in year one.
It also hurts when the penalty is large and the cash is small. Paying $12,000 to free $60,000 is a poor trade. And it hurts if you stretch the amortization to keep the payment down, because the agency warns that a longer amortization means more interest over time.
What it really costs
Add the penalty, any lender or appraisal fees, legal fees and the discharge fee to the extra interest on the whole new balance. The agency says a discharge fee, where not capped by the province, typically ranges from no charge up to $400, and that lawyer, notary or commissioner of oaths fees typically run between $400 and $2,500. Ask the new lender whether it will cover some of the costs, since the agency notes you can ask.
Then compare against the alternative over the length of time you will really hold the loan. The calculator lets you put both quotes side by side, and the second mortgage and refinance comparison explains the structure of each.
The risk to your home
You are putting a larger mortgage on your home, usually at a longer amortization, with a single lender holding the first claim. The agency warns of serious consequences, including foreclosure, if you cannot repay. Because a refinance replaces your old loan, there is no cheaper mortgage left behind to fall back on.
A bigger balance also leaves less margin if prices fall. At or near 80% of value, a decline in the market can leave you with little room to refinance again.
What to try before refinancing
Check whether you can avoid the penalty by timing. The agency suggests using prepayment privileges, which lower the balance a future penalty is based on, waiting until the end of the term, or porting the mortgage if you are moving. It also describes blend-and-extend, where the lender blends your old rate with a new one for a new term, which can limit the pain of a higher rate.
If you need less than the full takeout, a smaller loan or a second mortgage may cost less. If you need money for debt, a home equity loan keeps the first mortgage in place. And if the underlying issue is the debt itself, a Licensed Insolvency Trustee can explain a consumer proposal and the opening meeting with a trustee is usually free.
How the exit works
A refinance has no separate exit. It becomes your mortgage. It ends when you pay it off, sell, or renew at the end of the term. The decision that matters is the next renewal: with a larger balance, a single higher rate has a bigger effect. Run the payment at a rate two points above today’s, and ask whether you could still carry it.
If you plan to sell in a few years, a refinance with a long term and a stiff penalty may box you in. Look at the penalty terms of the new mortgage as well as the old.
What to ask before you sign
- The exact penalty on your current mortgage, in writing, and how the lender calculated it.
- The total cost of the new mortgage over the term, including the new rate on the whole balance.
- Which fees the new lender will cover.
- What the new penalty terms are, and whether prepayment privileges are included.
- The licence details of the professional arranging it, and how to check them with the regulator.
If you want to discuss whether a refinance or another route suits your situation with a licensed mortgage professional, you can check your options. Nothing here promises approval or a rate.
Penalty and cash on a $700,000 home when the owner breaks a 5% mortgage
Made-up figures. The owner owes $400,000 at an assumed 5% with 24 months left and the lender's current rate for that period is an assumed 3.5%. Using the agency's description, the penalty is the higher of three months of interest or the rate differential. The new loan is the agency's usual 80% limit. Legal and appraisal cost an assumed $2,500.
- Three months of interest
- $5,000
- Rate differential, 1.5 points for two years
- $12,000
- Penalty, the higher of the two
- $12,000
- New mortgage at 80% of $700,000
- $560,000
- Less the old mortgage, penalty and costs
- -$414,500
- Cash in hand
- $145,500
$400,000 x 5% / 4
$400,000 x 1.5% x 2
$400,000 + $12,000 + $2,500
A year of interest: refinance the whole balance or keep the first and add a second
Made-up figures, interest only, same $60,000 of cash needed. Refinance: $460,000 at an assumed 5.5%, with no penalty because the owner is at the end of the term. Keep the first: $400,000 at an assumed 3.5% plus a $60,000 second at an assumed 11%, fees ignored.
- Refinance, interest for a year
- $25,300
- First mortgage kept, interest
- $14,000
- Second mortgage, interest
- $6,600
- Keep the first and add a second
- $20,600
- Extra interest from refinancing in year one
- $4,700
$460,000 x 5.5%
$400,000 x 3.5%
$60,000 x 11%
Questions people ask
How is the penalty for breaking a mortgage worked out?
The agency says the penalty is usually the higher of three months of interest on what you owe, or the interest rate differential, which compares your rate with the lender's current rate for the time left. Your contract and your lender decide the exact method, so ask for the figure in writing.
Can I avoid the penalty?
Sometimes. The agency suggests using your prepayment privileges each year, waiting until the end of the term, or porting the mortgage to a new home. An open mortgage has no penalty. Each route has limits, so check your contract and ask what applies to you.
What is blend and extend?
It is an option where the lender blends your old rate with a new one for a new term. The Financial Consumer Agency of Canada gives an example: a $200,000 mortgage with 24 months left at 5.5%, renewed at 4% for a new 60-month term, blends to 4.6% for the 60 months. Lenders must explain how they calculate the blend, so ask.
Do I need to pay a discharge fee on a refinance?
Your old lender may charge one to remove its claim from the title. The agency says it typically runs from no charge up to $400 where fees are not capped by the province, with legal fees on top. A new lender may cover some costs if you ask during negotiation.
How much cash can I take out?
The agency says you can usually borrow up to 80% of your home's value. Subtract what you owe, then subtract the penalty and closing costs. What is left is your cash, and a lender may set a lower ceiling for your file or property.
Is refinancing better than a second mortgage?
Neither always wins. A refinance puts the new rate on your whole balance and may trigger a penalty. A second mortgage leaves your first mortgage alone but carries a higher rate on a smaller sum. The comparison is the whole cost over the time you will really hold the loan.