One of the many mortgage products available to you today is the cash back mortgage. Like credit cards with the same incentive, the borrower gets a certain amount of money back from the lender when their loan is finalized. If it sounds too good to be true, it probably is, right?
What is a cash back mortgage?
There is a time and a place for just about every mortgage product, and a cash back mortgage is no different.
A cash back mortgage is one in which a borrower receives money back upon the closing date, when the lender transfers the rest of their mortgage funds. The amount of cash that you get from the lender varies based on the size of your mortgage. You can get anywhere between 1-7 per cent, depending on your lender, but most mortgage products generally offer around five per cent of the amount of your mortgage. Lenders will specify whether or not their particular cash back mortgage product has a maximum amount that they will give you as cash.
Buying a home is expensive process, and the draw of the cash back mortgage is that you can use the money for some of those upfront costs, such as closing costs and moving fees. What it is not meant to do, however, is to cover, or help cover, the cost of your down payment.
As the Office of the Superintendent of Financial Institutions outlines, “With respect to the borrower’s down payment for both insured and uninsured mortgages, FRFIs [federally-regulated financial institutions] should make reasonable efforts to determine if it is sourced from the borrower’s own resources or savings. Where part or all of the down payment is gifted to a borrower, it should be accompanied by a letter from those providing the gift confirming no recourse. Incentive and rebate payments (i.e., “cash back”) should not be considered part of the down payment.”
That being said, there are still ways to get your down payment from a cash back mortgage product. Credit unions are not federally regulated, so many of them across the country are able to offer cash back mortgages that essentially act as mortgages that require no money down.
First-time buyers are often thought of as the prime targets for cash back mortgages because there are so many upfront costs that buyers have to come up with from scratch and generally are coming to the table with less cash because they haven’t had a chance to build up any equity, but repeat buyers can take advantage of them as well.
The down side
Having extra cash up front can be obviously useful, but it comes with a few catches. First of all, you’re going to pay for it in the end with a higher interest rate for the entire mortgage. How much higher? Sometimes lenders will use their posted rate, although the range is generally anywhere from 1-2 per cent more than they would for a more standard fixed rate loan. Note that it will also be a fixed rate mortgage; variable rate mortgages aren’t available with the cash back option.
A majority of first-time home buyers break their mortgage contract, even though most don’t think that they will. While breaking a mortgage always comes along with penalties and fees, with a cash back mortgage, more lenders will require you to repay all or at least part of the cash advance, on top of the penalties and fees that already exist for breaking the mortgage.
Mortgage broker Claire Drage says that cash back mortgages are a great option – as long as you pay attention to your potential for increased income, regardless of whether you qualify or not.
“We don’t want to put someone in a mortgage with a higher interest rate because it’s a cash back that they can’t afford. And then you’ve also got to look at a single individual with no kids and no partner has less expenses than a married couple with four kids. They both might qualify for the cash back, but is it right for both of them?”
Qualification itself may be another hurdle, as cash back mortgages tend to be available only to “good” borrowers – ones with long-term stated income, good credit, and favourable debt-income ratios. If you’re struggling to buy the home in the first place, then don’t count on the cash back mortgage to help you cross the finish line at closing time. Odds are, you might not even qualify for it at all.
When it works
As mentioned earlier, there are certain times when a cash back mortgage might make sense. One of these reasons would be that you need to make immediate repairs to your home before you’re able to move in and live there safely. Sometimes you may need cash immediately to make use of certain investment opportunities, such as RESP or RRSP contributions. In these instances, a cash back mortgage can give you cash without jumping through the hurdles for a separate loan. In the event that you’re refinancing your home instead of buying for the first time, you might decide that you need additional equity and so opt for a cash back mortgage instead of another product.
Paying down debt is another reason that a cash back mortgage may work. Unsecured consumer debt generally carries interest rates that are much higher than even the increased mortgage interest rate that comes along with the cash back option. Depending on the amount of debt you have, paying the extra interest over time with your mortgage could be worth it to you to get out from under the credit crunch – especially if your credit rating has suffered because of the debt. It may also be cheaper than getting a loan through a private lender.
Whether or not you decide to get a cash back mortgage, read the fine print and have your mortgage broker help you with the math of various scenarios, including comparing interest rates and amount of cash back. A cash back mortgage initially gives you more options, breathing room, and financial freedom initially, but that extra money upfront can really straightjacket you to your mortgage years down the line.
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