If you are a home buyer with less than 5% in cash for a down payment you may want to consider some other options. Is a cash back mortgage a good deal?
Is a cash back mortgage a good deal
There are some financial institutions offering cash back towards your down payment as incentive for a home buyers business. At first glance the opportunity to receive 2.5% may be appealing. Regardless of the offer it is important to do your homework or better yet review all your options with your mortgage broker.
Let’s use Adam and Nicole as an example. They have $10,000 in savings and want to buy a $400,000 condo in Vancouver. Their cash savings covers only 2.5% of the down payment so they are considering a cash back option from a local credit union. The cash back of 2.5% is available if they lock into a 5 year fixed mortgage with a premium to rate. The cash back rate will be 3.69%. Competitive 5 year fixed rates are 2.99%
If we consider that Adam and Nicole can easily qualify for the mortgage with good income and credit and the lack of down payment is the only missing piece to their ability to buy their new home.
Note. Mortgage Insurance protection premiums will rise effective May 1,2014 to 3.15% for 5% down from own cash OR 3.35% if the down payment is from other sources such as cash back or borrowed from a line of credit.
If Adam and Nicole had the full 5% down their mortgage would be $391,970 net of the down payment and including $11,970 in insurance premiums for a high ratio purchase. Bi-weekly payments at 2.99% would be $854.65 . Their cost of borrowing over the 5 year term would be $54,104.53 if they didn’t make any changes to their payments.
Since Adam and Nicole don’t have the full 5% down they are considering a cash back mortgage including 2.5% towards down payment. Because they are sourcing the extra money for down payment from the lender they will pay a higher rate (3.69%) and the mortgage insurance premium will rise to 3.35%. The mortgage will be $392,730 net of the down payment of $10,000 from the lender and $10,000 from their cash and including $12,730 for the insurance premium. Bi-weekly payments will be $922.49. Their cost of borrowing over the 5 year term would be $67,210 ($13,000 more in interest to borrow that extra $10,000).
Another option for Adam and Nicole may be to obtain the 2.5% additional down payment required as a gift from a family member. If that isn’t an option they could obtain an unsecured line of credit for the $10,000. At an interest rate of 5% and payments of $300 per month they could pay off that loan in 3 years with a total cost of borrowing of $780. In this case they could access the best rates at 2.99% and bi-weekly payments for their mortgage of $392,730 would be $ 856.30 and cost of borrowing over the term of the mortgage would be $54,209 plus the $780 for the line of credit for a total of $54,989 still much lower than the cost of the cash back option.
So, is a cash back mortgage a good deal? Talk to your mortgage broker and then you decide.