Buying a property involves many costs that, when added to the down payment, can strain a household's savings. As a result, any opportunity to get cash might seem like a good one to take advantage of.
Cash back mortgages are sometimes offered by financial institutions as an incentive to encourage you to take out a mortgage with them. However, while it might seem like a win-win solution, it’s important to remember that this cash is far from a gift from your bank. Before signing, it’s essential to consider both the short-term benefits and the long-term consequences.
If you’ve never heard of a cash back mortgage, the concept might be surprising, but it’s not impossible.
What is a cash back mortgage?
Some lenders offer a financial product that allows you to receive a lump sum in addition to the amount you borrow. The cash-back amount typically ranges from 1% to 7% (with 5% being the most common) of your mortgage value. Once the property acquisition is complete, you receive the full cash back amount directly into your bank account.
There are no restrictions on how you can use this money. You can spend it on home renovations, buying furniture, covering various acquisition costs, and more. Depending on the lender, you might even be able to use it to increase your down payment. If this is a product you are interested in, it's crucial to confirm with your lender whether this option is available before signing any agreements.
What are the conditions related to this type of mortgage?
As mentioned earlier, the cash back is certainly not a gift. To offset this offer, the mortgage you take out for your property purchase will likely come with a higher interest rate than the standard rate, typically 1% to 2% higher. This means your loan will ultimately be more expensive over time compared to a traditional mortgage. Additionally, this option is generally only available with a fixed-rate loan.
One important condition to be aware of is the requirement to repay the cash-back, either partially or in full, depending on the financial institution, if you decide to terminate your mortgage early or refinance. This repayment will, of course, be in addition to any standard penalties for early termination or refinancing.
What are the pros and cons of cash back mortgages?
The primary advantage of this type of loan, as you may have already guessed, is that it provides immediate liquidity. There are no restrictions on how you can use the cash back funds, so you could even use them to pay off existing debts, which would help reduce your monthly expenses.
What are the disadvantages?
The main downside of a cash back mortgage is the higher interest rate. The interest rate on these loans is typically 1% to 2% higher than standard mortgage rates, which means your loan will be more expensive over time.
It's important to do your calculations before finalizing your decision. If you're not careful, the additional interest you pay could end up being greater than the cash back amount you received.
Let’s break it down with an example:
-
With a traditional mortgage, you might pay $43,000 in interest on the loan amount.
-
With the higher rate of a cash back mortgage, that amount could rise to $49,500.
-
The additional interest paid would be $6,500. If the cash back you received is less than this amount, you essentially end up with no net gain in the long run.
When could a cash back mortgage still be worthwhile?
One situation where a cash back mortgage might still make sense is when purchasing an income property. This is because the interest on the mortgage is tax-deductible, which helps offset the higher interest costs. Additionally, rental income from the property should ideally cover the mortgage repayments, so the added expense might not have a significant impact on your personal finances.
Other mortgage products that provide liquidity
If your need for liquidity isn't immediate, there are other financial products that can help you access funds for secondary expenses.
Home equity line of credit (HELOC)
A home equity line of credit (HELOC) is a secured, renewable credit product that allows you to borrow against the equity you’ve built in your home. It can be used to partially finance the acquisition costs of a property or fund various other projects, such as renovations, debt consolidation, or large purchases.
Your home serves as collateral for the loan, and you can borrow up to 65% of the property’s market value. You must have a minimum down payment or equity of 20% in your home.
A HELOC offers more flexibility than a traditional loan, as you can draw on the credit line as needed, similar to a credit card, and only pay interest on the amount you borrow.
Subordinate mortgage
A subordinate mortgage, also known as a collateral mortgage, allows you to borrow additional funds without needing to register a new mortgage. This works because the lender registers a mortgage for an amount greater than your original loan, enabling you to access extra funds as needed.
The loan amount can be based on the anticipated increase in the property's market value, allowing you to borrow up to 125% of the property’s value at the time the loan is issued. It’s a flexible option for homeowners who want to access extra funds over time without going through the process of registering a new mortgage each time.
Choosing the right mortgage for your situation
Is opting for a cash back mortgage a good idea? Unfortunately, there's no one-size-fits-all answer. Whether it’s the right choice for you depends on your specific situation. Consider these key questions:
-
Do you need liquidity immediately? If you require quick access to funds for home improvements, debt consolidation, or other expenses, a cash-back mortgage may be appealing.
-
What will the impact of the additional interest be? It’s important to weigh the cost of higher interest rates against the benefit of receiving cash up front. Will the extra interest cost outweigh the cash back you receive in the long term?
-
Are you focused on the short term or the long term? A cash back mortgage might provide immediate relief, but it could cost you more over the life of the loan. If you're planning to stay in the property for a long time, the added costs may become significant.
In any case, the best way to find the mortgage product that suits your needs is to consult with a mortgage broker. They can help you compare options and guide you toward the right solution based on your financial goals.
Are you looking to secure a mortgage loan?
XpertSource.com can help you in your efforts to find a mortgage broker. By telling us about your project, we will refer you to top-rated experts, free of charge! Simply fill out the form (it only takes 2 minutes) and you will be put in contact with the right experts.
