Cash Back Mortgages Examined
After the federal government prompted the end of $0-down insured mortgages in July, speculation immediately started about how people will get around this new restriction. Cash back mortgages quickly took centre stage.
Cash back mortgages have been around for a while. They effectively let people finance beyond the 95% loan-to-value limit and were a precursor to 100% financing.
Now there's a chance cash-back mortgages will also be on the chopping block.
The Department of Finance knows full well how cash-back mortgages can simulate 100% financing, and they'll likely provide public comment on them at some point. (We've asked and are awaiting response.)
In the meantime, Canada's biggest bank, RBC, says it "will not
offer cash back as a financing alternative to the 5% down payment."
In addition, TD--which last month sent an email to brokers confirming its cash back products--said in the Globe & Mail that it will be "revisiting" whether to keep certain cash back products in the market. TD said, "once they have clarified things" they may "pull" one or more of their cash back products.
As of today, however, TD still had ads on its site for the CashBack Down Payment Mortgage. The product's tagline says: "Not having a down payment doesn't need to keep you from buying a home."
One thing's for sure, cash back mortgages are worse than the 100% financing they'll replace.
We don't want to pick on TD, but for illustration we'll use their CashBack product as an example. TD sends 5% of the purchase price to the borrower's lawyer on closing. All one has to come up with is 1.5% for closing costs. It's a nice little dance around the new 95% loan-to-value rules.
The cost of this generosity is at least a 1.35% higher interest rate. That's because TD charges 6.85% for this product (as of today) and one can go elsewhere and get 5.50% or better on a non-cash-back mortgage.
So let's assume you buy the average Canadian house for $302,298. You put down 5% of your own money and get a mortgage with a 25-year amortization at 5.50%. This will cost you $74,124 in interest over five years.
If, however, you use TD's money for the down payment (i.e. TD's CashBack Down Payment Mortgage), you'll pay an extra $18,755 in interest--according to our calculations.
If you put up that $15,114 for the down payment yourself, you'd save all of this interest. It would be like earning 124% on your down payment money in five years--or 17.5% a year after taxes!
Rob Carrick of the Globe & Mail also warns that banks charge big bucks if you break a cash-back mortgage early. The additional interest penalty can be thousands of dollars. You'll also have to pay back a pro-rated amount of the cash back if you exit before maturity.
We had a client who got $25,000 cash back but then wanted to refinance a year into his 7-year cash-back mortgage. He had to pay back over $9000 in penalties plus repay $21,400 of his cash back.
Another big downside to cash-backs is that they're generally unavailable with variable rates. Most of our readers know that, statistically speaking, variable-rate mortgages entail less interest over the long-run.
Don't let us be the only detractors, though. Here's a small sampling of what others have to say about cash-back mortgages:
- "The math is not beneficial to clients. They always will lose." - Vince Gaetano, Monster Mortgage
- It's "a horrible product" - Jim Tourloukis, Advent Mortgage Services.
- "Banks never offer their best rates on a Cash-Back mortgage." - True North Mortgage
Million Dollar Journey has an excellent discussion going on the topic if anyone is hungry for more information.
(All above figures are as of today, September 2, 2008)
