What is a Cash-Back Mortgage?
Of all the different types of mortgages available, an often less discussed type is the Cash-Back Mortgage. At Oceanvale Mortgage & Finance, and as a mortgage brokerage serving the community in Nanaimo, we’re eager to help you with whatever product fits your needs.
A cash-back mortgage offers you the flexibility to receive from 1-3% of the total mortgage amount in the form of cheque from the lender. This is a smart product to consider if you need extra cash after the mortgage closes to cover things like closing costs or moving expenses. For example, let’s say you purchase a home for $300,000 with a 5% down payment making your total new mortgage $285,000 but want a little bit of extra money to pay off some debt after your purchase completes. You could receive a cheque from the lender for up to $8,550 in this example and use it for whatever you want!
The question is: why is the lender so willing to hand over cash? By offering a cash-back, they take away your opportunity to negotiate. If you decide to get a cash-back mortgage, you’ll find yourself paying a higher interest rate than what a standard mortgage would offer you.
For a better understanding, below there is a detailed example of what the associated costs are for a cash back mortgage and a traditional mortgage:
With a purchase of $400,000 and a down payment of 5% which is $20,000 the total mortgage amount is $380,000. With a traditional mortgage, the interest rate could be as low as 2.59%. That would leave the new homeowner with a monthly payment of $1,709.85. Over a 5 year term (or 60 months) and a 25 year amortization, the homeowner will end up paying $44,473.87 in interest and the total outstanding mortgage balance would be $ 321,882.87.
For the same purchase price, down payment, and total mortgage amount, the cash back mortgage rates as of January 10th 2017, for 3% cash back, are currently set at 3.84%. This increase in the rate is intended to off set the $11,400 that the new homeowner will receive as cash back. With this higher rate the monthly payment will amount to $1,966.05. With the same term and amortization as previously stated, the homeowner will end up paying $ 67,840.08 in interest on the mortgage. The outstanding balance will be $ 329,877.08.
As you can see with the cash back mortgage, the homeowner ends up paying significantly more interest over the 5 year term and less towards the principal balance. As far as the monthly payments, the difference in $1,966.05 - $1,719.35 = $246.70. Over a 60 month term the extra cost ($246.70 multiplied by 60 months) accumulates to $14,802. Now, subtracting the $11,400 cash back amount from the $14,802 there is still $3,402 left over that would be the cost of the initial cash back advance for the homeowner to pay over the term.
There are penalties if you refinance, transfer, or renew your cash-back mortgage before maturity. Also, these types of mortgages are only available on fixed term mortgages with a minimum term threshold. Typically, a cash-back mortgage includes a clawback clause. If the borrower sells the property, pays off the mortgage with the proceeds and doesn’t replace the mortgage with a mortgage on a new property, then the original sum you’re required to pay back on a prorated basis plus substantial penalties. It can add up.
For some first-time home buyers, the allure of purchasing their first home without a significant down payment can be very tempting. There maybe circumstances where a cash-back mortgage is required but I would always recommend speaking with a professional to help decide what’s best for you.
Deciding which mortgage product is right for you can be a daunting task. At Oceanvale Mortgage & Finance we are always here to help. We will take the guess work out of what is most beneficial for you when mortgaging a home. Contact us today!