*This post was created in collaboration with Alpine Credits
While most new homebuyers anticipate saving for a down payment, there are often unanticipated expenses that pop up like closing costs or additional moving expenses. To ensure you have enough money to cover all of the costs associated with homeownership, you might consider a cash back mortgage.
What Is A Cash Back Mortgage?
With a cash back mortgage, you can borrow more than you need for your mortgage and take the extra money as a lump sum payment. You receive the cash back portion when your mortgage closes. You can use the cash for almost anything such as closing costs, lawyers’ fees, and renovations.
Features Of A Cash Back Mortgage
| Mortgage Amount | You can typically borrow 1% to 7% of your mortgage amount. Some banks set a maximum cash back amount. |
| Interest Rate | Cash back mortgages have an interest rate that is, on average, higher than a standard mortgage. |
| Term Lenght | The cash back amount is added to the total mortgage balance and paid back monthly for the term of your mortgage. |
How Does A Cash Back Mortgage Work?
With a cash back mortgage, your lender allows you to borrow more than the amount needed to buy the home. This additional amount of money is tacked onto your mortgage loan. Generally, lenders allow cash back amounts that range from 1% to 7% of the mortgage amount.
This amount is paid out when your mortgage closes. So you’ll be able to use the extra cash for closing costs, lawyers fees, or any other expenses. However, do note that cash back mortgages carry a higher interest rate, which is applied to the entire mortgage amount, not just the extra cash back you get.
For instance, say you want to purchase a home for $500,000. You’ve saved up 20% ($100,000) for a downpayment, so you need to borrow $400,000 from a bank or lender. Your lender offers the option of a cash back payment ranging from 1% to 7% of your mortgage. If you wanted 5% cash back on your mortgage, you could get a payment of $20,000.
Your total mortgage would then be $420,000. The cash back mortgage interest rate would apply not this entire amount, not just the $20,000.
What Can You Use A Cash Back Mortgage For?
One of the benefits of a cash back mortgage is its flexibility. You can use the cashback amount for almost anything you want. Some common uses include paying for:
- Closing costs
- Home renovations
- Moving expenses
- New furniture
- High-interest debt
| Note Some lenders have restrictions on how you can use the cashback amount. For instance, they might state you can’t use the cash back amount towards your down payment. This makes sense as the cash back payment isn’t released until after your mortgage closes. |
How Much Do Cash Back Mortgages Cost?
Cash back mortgages are more expensive than regular mortgages for two reasons:
- You’re borrowing a higher amount of money
- Interest rates are usually higher for cash back mortgages
In general, cash back mortgages come with an interest rate that is 1%-2% higher than standard mortgages. The increased rate is applied to your entire mortgage, not just the cash back amount.
This means you will pay more in interest over the course of your mortgage. To illustrate how much more you could pay in interest, here’s an example.
| Regular Mortgage | Cash Back Mortgage | |
| Mortgage Amount | $500,000 | $525,000 ($500,000 mortgage +$25,000 cash back) |
| Interest Rate | 3.5% | 5% |
| Term Lenght | 5 years | 5 years |
| Total Interest Paid Over 5 Years | $81,181 | $122,870 |
In this example, you’ll pay $41,689 more in interest if you decide to add $25,000 in cash back to your mortgage. Before taking on a cash back mortgage, it’s important to consider if the extra $25,000 in the short term is worth paying $41,689 more in interest.
What Happens if You Break Your Cash Back Mortgage Term Early?
If you find a better mortgage rate and decide to break your mortgage to refinance your cash with a different company, there are usually consequences. Many lenders will require you to pay back part or all of the cashback amount.
You might also have to pay a prepayment penalty. Make sure you know what will happen if you break your mortgage and ask if there are prepayment penalties.
Benefits Of A Cash Back Mortgage
The benefits of taking on a cash back mortgage include:
- Not taxable. You won’t have to pay taxes on the lump sum of money you receive from a cash back mortgage.
- Access to cash. Having some extra money on hand can help new homeowners, especially first-time buyers, to cover home expenses, new furniture, or high-interest debt.
- Flexibility. You can use a cash back mortgage to pay for pretty much anything – closing costs, furniture, or home renovations.
- Simple. A cash back mortgage provides a simple and efficient way to access a lump sum of cash. Rather than having to apply for a separate loan, you can roll it all up into one payment.
Drawbacks Of A Cash Back Mortgage
There are also important downsides to consider before taking on a cash back loan, including:
- Higher interest rate. Cash back mortgages generally have a higher interest rate than traditional mortgages, so you might end up paying more in interest than you get in cash back.
- Clawbacks. If you break your mortgage before the end of your term, you may have to repay the loan in part or in full.
- Prepayment penalties. If you want to break your mortgage and pay it off early, you might have to pay a prepayment penalty.
- More debt. When you take on a cash back mortgage, the extra money is added to your mortgage balance. This results in a larger mortgage and more interest charges.
- Restrictions. Because the cash back payment isn’t paid out until your mortgage closes, you can use the money towards your down payment.
- Qualification. It’s generally harder to qualify for a cash back mortgage versus a standard mortgage. You’ll need to demonstrate a high credit score, consistent employment, and a low debt-to-income ratio.
Alternatives To Cash Back Mortgages
If you’re not sure if a cash back mortgage is right for you, there are alternatives to consider, including:
Readvanceable Mortgage
This alternative allows you to borrow for the equity you’ve built in your home. It combines a revolving home equity line of credit (HELOC) with a fixed-term mortgage. With the HELOC, you can borrow from the principal you’ve paid down on your mortgage. You only pay interest on the money you use. With the fixed mortgage, you continue to make regular payments to cover the principal and interest amount.
RRSP Home Buyers Plan
With the home buyers plan (HBP), you can withdraw up to $60,000 from your registered retirement savings plans (RRSPs) to purchase or build a qualifying home.
Second Mortgage
If you don’t need the money immediately, you can wait till you build some equity in your home and then take out a second mortgage with your current lender or an alternative lender like Alpine Credits. A second mortgage comes in many forms including a HELOC and home equity loans. Both options allow you to borrow a large sum which you can use for any purpose including repairs, renovations and even consolidating debt. Do note that second mortgage interest rates on a second mortgage are generally higher than on first mortgages. Moreover, you’ll have to pay off the second mortgage, while continuing to pay off your original mortgage.
Personal Loan
With a personal loan, you can borrow a fixed amount of money and pay it back over time. Most personal loans range from $100 to $50,000 with terms of six to 60 months. A good credit score can help you secure a low interest rate.
Line of Credit
A line of credit functions like a credit card. You can use the money when you need it, pay it back, and then use it again. You only pay interest on the amount you use. The interest rate is typically variable, which means it can go up or down based on the prime rate. Similar to a personal loan, a higher credit score can help you secure a better interest rate.
Bottom Line
While a cash back mortgage is available if you need extra money to pay for closing costs or home renovations, it requires you to take on more debt at a higher interest rate than a conventional mortgage. Before taking on a cash back mortgage, make sure you understand how much more you’ll pay in interest versus a standard mortgage. You can ask if there are prepayment penalties and if there are any restrictions on how you can spend the money. Also, compare alternative options to see where you can get the best deal.
