Cash Back Mortgages Examined

Cash-Back-Mortgages 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 that interest.  

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)

  1. Cash back is a sham. Quick buck, but in the end you get screwed via paying more in interest to the banks, now if they offered cash-back with a discounted rate that was similar to what’s offered now as a discounted rate, well then we’d have a product–but that will not happen, stay away.

  2. “Not having a down payment doesn’t need to keep you from buying a home.”
    Canada may have limited subprime lending, but we certainly don’t care about leveraging debt onto consumers so they’re up to their eyeballs.
    Now that the global housing crunch has come to Canada, there’s going to be serious repercussions for people extended beyond their means.

  3. Above it says that you pay an additional $18,755 in interest over five years than if you came up with the $15,114 downpayment. This is true, but the bank is giving you the $15,114 down payment so the premium you are being charged is actually the difference between the two numbers (this works out to about $3,641 over 5 years (or $60 bucks a month). The way I view cash back mortagaes is that the bank is lending you the down payment as part of the mortgage and you most certainly pay a premium for that service, but it is not that extreme compared to taking a loan on a line of credit etc. to pay a down payment. Not everyone wants to wait five years to buy a house or can borrow money from parents or have family contribute to thier first house. There are some people for whom a cash back mortgage works.
    I had kids in university and lived in a very samll space until I got a job after graduation. A few years after graduation I knew my line of employment was ‘secure’ and my wage had quadrupled since graduation and renting a house was the same cost per month as buying a townhouse in my city. Now I could save for four or five years to get the down payment, but since I needed a bigger place immediately saving would have been more difficult at a higher rent. Plus I wanted a place for my kids when they were young, not when they were teenagers and were never home anyway. Instead, for $60 bucks a month more I bought my own place. People need to be aware of the implications of the cash back mortgage, but I think there is a small demographic for which this product is beneficial and alloows people to accrue equity earlier by getting them into the market five years earlier, instead of frittering it all away on outrageous rents.
    In some places owning a home can be a bit like chasing the carrot, everytime you think you have enough saved for a downpayment, the housing prices increase and you need more and when you have saved that, they increase again. This is another dempgraphic that it can work for, those who have been saving but needed a little bit more to get into the market and cover moving expenses etc. You just have to be prepared to stay there for the term of the mortgage so you don’t pay a penalty.

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