A few weeks ago, you were making one of the most important moves of your life. You have been discussing this plan for a while, you have dreamed about it and you finally did it. Your dream will come true in a few weeks and you just can’t wait to smell the odour of fresh paint in your new living room of first new house… A few weeks ago, you signed an offer to purchase your new home, congratulations!
But before sitting in your brand new couch in your brand new house, you need to get a brand new mortgage ;-). This is when you come across a huge billboard advertising a cash back of 5% – 5.5% on your mortgage. Man, this is perfect! You were just thinking of renovating the kitchen! Hey wait… your mortgage is $200,000… this means that you will get $10,000 in your pocket to buy that house! VIVA EL CASH BACK! Not so fast buddy…
Before we start about whether mortgage cash back is good for your situation or not, you need to understand how a bank does its pricing for mortgages. There are 2 things that can be adjusted: interest rates and the amount of cash back. Since the interest rate war has been pretty rough on any banks these the past 12 months, some banks are starting to play on the other side of the equation; they are talking cash back. The more cash back you get in your pocket, the less you can negotiate the interest rate (and vice-versa).
The easiest way to know if you should take the cash back or the low interest rate is to do a small math calculation by comparing both options. Let say that you have a $200,000 mortgage. Therefore, you have 2 options:
– get a cash back of $10,000 (5%) and an interest rate of 5.85%
– get no cash back and a low interest rate of 4.35% (you can usually get about 1.00% to 1.50% off the posted rate).
When you see huge cash back mortgage promotions, they usually offer it on 5 year term mortgage (fixed) and give you the posted rate. Then, you just have to calculate (roughly) how much you save in interest over the next 5 years: ($200,000*(5.85%-4.35%)*5years = $15,000. While this is a gross amount (since your principal will decrease according to your payment), you can see that the cash back is not that of a great option. If you decide to go on a variable rate, you will be able to save even more money ;-).
There are a few situations when cash back is a good thing (while most of the time, cash back mortgage is just another marketing gimmick 😉 ).
If you need money to renovate or to buy a second car since you are moving away from your job, the cash back option can help cover those costs right now. Don’t forget that if you save $15,000 instead of $10,000 in my previous example, you don’t get the $15,000 in your pocket, it is just decreasing your mortgage payments over the next 5 years. So if you need a few thousand for a specific project, it may be worth it.
Young couples often use the cash back as cash down on their property. It may be a good strategy to buy a house in a hot market. If you wait 2 or 3 years to buy the very same property, inflation will work its magic and it will be more costly than taking the cash back today in order to boost your cash down.
This may be a really good strategy for rental property owners. Since the interest rate is tax deductible (and mostly paid by your renters anyway), you are probably better off with additional cash in your pockets (that can cover maintenance, an empty apartment, etc.).
So the Cash Back mortgage promotion is not that bad after all
As is the case for many financing or investing products, cash back mortgages can be a really good idea for some people in specific financial situations. All I am saying is don’t get hooked by the 5% cash back without asking questions and without asking what other mortgage options are offered. In the end, you could take a variable rate with appraisal and notary/lawyer fees paid instead of taking a huge cash back… just discuss your options with your banker 😉
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