The idea behind a cash back mortgage is simple: when you purchase a home and your mortgage closes, the lender advances you an extra lump sum of money in the form of a ‘cash back.’ New homeowners often put that money to work to cover last-minute expenses associated with buying a home – things like moving, renovations, furniture, legal fees and closing costs.
The problem: as with all mortgage incentives, you’ll there’s a cost associated with a cash back mortgage. If you’re wondering whether a cash back mortgage is right for you, read on to find out how it works, and the pros and cons of the cashback option.
How does a cash back mortgage work?
When you take out a cashback mortgage, you’re really taking out a loan for more than the cost of the home you’re buying. That excess loan can be calculated as a fixed amount (say $5,000) or as a percentage of your home’s value (usually between one and seven percent).
How do I get a cash-back mortgage?
You’ll find plenty of lenders offering cash back mortgages in Canada, but in general, you need to have a steady job (self-employed folk are usually ineligible), as well as a decent credit score. Lenders also want to know if you will be living in the home, rather than renting it out.
Once you’ve applied for a cash back mortgage, your lender will let you know how much money you’re able to get. If your application is approved, you will receive the cash back to spend however you choose, either once you close on your home or after you’ve made your first monthly mortgage payment.
Is a cash back mortgage a good idea?
There’s no doubt that extra cash comes in pretty handy when you’ve just purchased a home. But be aware that there are some drawbacks to cashback mortgages. For example, you may pay a higher interest rate on your overall mortgage, and there may be tricky terms that can cost you over time. Armed with the following information, you can at least make an educated choice.
Advantages of cash back mortgages
- You get cash when you most need it – Having a lump sum of cash up front can help you cover some of the predictable and unpredictable costs associated with your first year of home ownership. For example, if you’ve purchased a $400,000 home and made a down-payment of $80,000, even a one percent cashback option would leave you with $3,200 in your pocket for an emergency.
- It could save your bacon in the short term – If you use your cashback to avoid or pay down high-interest credit card debt, it could lower your monthly bills by replacing lower interest debt with high-interest debt.
Disadvantages of cash back mortgages
- It may be harder to qualify – As mentioned, self-employed people and those with a less-than-stellar credit history could have trouble getting a cash back mortgage.
- Additional terms can cost you in the long run – When you take on a cash back mortgage, you’re typically agreeing to additional terms, and those terms vary from lender to lender. Look out for things such as repayment and flexibility.
- You might pay a higher interest rate – Typically in Canada, you’ll pay a higher interest rate on a cash back mortgage; usually about 1.75 percent more than on a standard fixed rate or variable rate mortgage without a cashback option.
- You will likely pay a penalty if you refinance – If you refinance or break your mortgage contract early by moving, you will likely have to repay at least some of the cashback. In fact, some lenders want to be reimbursed for the total amount, and there may be a penalty or repayment premium on top of that.
What should I look for in a cash back mortgage?
If you decide a cash back mortgage is the right choice for you, keep in mind that there are plenty of options on the market, and some outshine the others. Ultimately, you should probably seek the lowest rate possible, combined with the greatest flexibility.
Cash back mortgage alternatives
So what if you need to boost your cash reserves and monthly payments, but after considering the pros and cons you’ve decided a cash back mortgage isn’t your best bet. Here are some alternatives that can put money in your pocket in those crucial early years of home ownership.
Cash from RRSPs or investments
It’s not always a good idea to cash in retirement savings or investments because you can end up paying higher taxes come tax season. Keep in mind, though, that the Home Buyers Plan allows first-time buyers to borrow up to $35,000 from an RRSP to help with the down payment and other closing expenses.
Line of credit
Interest rates on a line of credit are usually lower than on a personal loan, and they tend to be more flexible. With a line of credit, you can borrow money up to a pre-set limit and you don’t have to use the funds for any specific purpose.
Even better, a line of credit offers a lot of flexibility. For one thing, you only pay interest on the funds you actually access. For instance, if you have a $100,000 line of credit, but you only need $25,000, you pay interest only on the amount you borrowed. You can also pay back the funds at any time (for instance, when your end-of-year-bonus comes in). Often you have to pay an administration fee to set up your line of credit.
If you have a good credit score, it’s generally not difficult to get a personal loan at a fair interest rate.
A low-interest or no-fee credit card can help you cover expenses in the short term or pay them off over time if necessary. Keep in mind, though, that even low-interest credit cards tend to have a higher interest rate than most other options.
Mortgage broker cash back
Some mortgage brokers will offer you cash back when you go with them. This is where they share the commission with you.