90% Insured Refinances Live…Sort Of

RefinanceLast month the government abandoned its support for refinances above 85% loan-to-value. (See: New Mortgage Rules)

That’s made life harder for people with circumstances that require greater access to their equity.

A few uninsured lenders will still permit refinances up to 90% LTV, but the rates are steep.

A much lower-cost option is one that may not be intuitive—a cash-back mortgage. Cash-back mortgages make near-90% LTV refinances possible, and cost less than some might think.

National Bank, for example, has a five-year 5.5% cash-back mortgage promotion. It’s available through brokers and branches. The current fixed rate is 5.34%, which sounds high, until you do a few calculations.

National-Bank-MortgageThe effective rate of National Bank’s cash-back mortgage is actually far lower than 5.34%. That’s because the borrower gets $5,500 cash for every $100,000 of mortgage, which directly offsets a portion of the interest cost.

According to National Bank, “The exact effective rate would be 3.965%” with a 25-year amortization.

That’s a respectable rate given that:

  • Regular discounted 5-year fixed rates are only 15-20 basis points lower (mind you, you can’t get those lower rates on a refinance above 85% LTV)
  • A cash-back mortgage saves you the additional insurance premium that would have previously been charged on refinances to 90% LTV. Those extra premiums used to be:
    • 1/4% of the entire mortgage amount; or,
    • 3/4% of the new money—for refinances of already-insured mortgages.

firstlineOther lenders have cash back mortgages too. As of today, status brokers at FirstLine, for example, can obtain 5% cash back on mortgages closing in 30 days. FirstLine includes 1/2% less cash back than National Bank, but the rate is slightly lower (5.09%) and the clawback is less.

“Clawback” refers to the cash that the lender makes you pay back if you break the mortgage early. If you discharge your mortgage after two years, for example, a lender will make you return 60% of the cash back you received, or more.

Clawbacks are serious business; so if there’s any possibility you’ll break your mortgage before 4-5 years, the math on a cash-back mortgage won’t be as good.

That said, if you move, you may be able to port your cash-back mortgage to the new property—with no clawback or penalty.

To get a cash-back mortgage you need decent credit. That usually means a Beacon score of 650 or greater. Depending on the rest of your application, however, it’s possible to get approved with a Beacon as low as a 600.

Among other things, lenders will also want to ensure your debt ratios are reasonable and your income/employment is solid.

All in all, cash-back mortgages can be a cost-effective solution for those who need ~90% financing and have no better options.

Sidebar: Cashback mortgages are also available on purchases, providing near-100% financing. If you don’t have a down payment, however, you’re probably better off renting. We generally advise folks to avoid cash-back down payment mortgages unless they absolutely must buy now, will be in their home over 5 years, have a source of liquidity (for emergencies) and expect significant income growth.

Rob McLister, CMT

  1. robert. so what you’re saying is if you took a 5% cash-back and deposited that into the principal right away, your effective rate is 3.96%
    if you took the cash-back and used it as a down payment, then your rate is 5.34 or 5.44, right?

  2. I’m pretty sure that what he’s saying is that because you’re getting 5.5% of the mortgage as cash in hand the rate on the principal adjusted to account for the cash would work out to be the lower rate. You use the money as down payment and your rate is still 3.96% because you’ve borrowed the cash-back funds.

  3. I guess, but I wouldn’t see it that way as a client, because the spread between 3.96 and 5.34% in payment is huge.

  4. Hi Jake,
    The calculation procedure isn’t the most intuitive so it’s good that you asked.
    For 5% cash back mortgages, the actual rate charged on principal is usually the posted rate (5.34% today) or slightly below. That rate is the same regardless of whether it’s a purchase or a refinance.
    The effective rate is always lower, however, for both purchases and refinances. That’s because the lender is handing you cash at closing that you didn’t have before. Essentially, that cash must be factored into the total borrowing cost of the cash-back mortgage to make it a fair comparison.
    To approximate the effective rate of a cash-back mortgage, set the interest rate of the non-cash back mortgage at a rate that generates the same total interest cost over five years as the cash-back mortgage.
    For a more apples to apples comparison it helps to:
    * Assume that the cash back will be used to make an immediate pre-payment on the cash-back mortgage; and,
    * Set the payments for the non-cash-back mortgage to equal the (higher) payments of the cash-back mortgage.
    This method isn’t exact (e.g., it doesn’t account for time value of money, exact discount rates, etc.) but it’s close enough.
    If you’re purchasing instead of refinancing, the cash-back still reduces your total borrowing costs. That’s because it’s money that you don’t have to pay back (unless you break your mortgage contract of course).

  5. Kind of a backwards way of looking at it.
    Good way to push cashbacks though.
    Rob try and answer this question.
    Would I be better off getting a cashback or a equivalent loan from a bank at 10%?

  6. @Jake – Try calculating your monthly payments with credit card debt at 20% interest. I think you’ll find the cash back payment compares well.
    @john – The cashback costs less.

  7. Swing and a miss.
    I guess that’s why they are so popular no one can figure out how much they really cost.

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