With a cash back mortgage, your lender provides you with a lump sum cash payment once they finalize your mortgage contract.
The cash amount is typically between 1% and 7% of your mortgage amount.
The purpose of a cash back mortgage is usually to help cover some of the expenses you’re likely to encounter once you take possession of your home.
These include costs associated with renovations, landscaping, and furnishings.
The cash infusion can also help stabilize your budget and supplement your income.
The extra funds are beneficial particularly if you’ve exhausted a sizable portion of your savings on hand to pay for your down payment and closing costs.
You can use the money to catch up on past-due bills, settle high-interest debt, or top up your savings account.
Banks and credit unions typically offer cash back mortgages to borrowers with good credit scores (minimum of 650), low personal debt service ratios and steady incomes.
How Does a Cash Back Mortgage Work?
Once your cash back mortgage is closed, your lender will deposit the predetermined lump sum of cash into your bank account.
You can then use the funds at your discretion.
However, you don’t get access to this cash with no strings attached.
Your lender would assign you an interest rate higher than the one you’d be entitled to if your mortgage contained no cash back feature (1% – 2% higher).
So, in reality, the cash rebate is embedded in extra future interest costs, which you’ll service through your regular mortgage payments.
The option to receive cashback is available only on fixed-rate mortgages.
Depending on your lender’s policy, you could choose a mortgage term from one to 10 years.
And though you could potentially receive a cash payment equal to 7% of your mortgage, certain lenders impose a cap on the dollar amount they’ll grant to you.
For example, RBC limits cash back mortgage holders to a lump sum payment of $20,000.
Let’s look at an example of how a cash back mortgage works in practice.
Suppose you buy a home for $300,000 and contribute a 20% down payment, meaning you require $240,000 in mortgage financing.
You qualify for a 5-year fixed-rate mortgage at 4.75% with a bi-weekly payment frequency.
You inquire with your lender about cash back options, and they offer you a lump sum worth 3% of your mortgage.
However, for this privilege, you’ll have to pay a 1% premium on top of your mortgage rate, meaning your contracted rate would increase to 5.75%.
Should you accept the cash back mortgage deal, the lender will provide you with a lump sum cash payment of $7,200 ($240,000 x 3%).
You’ll gradually repay this amount through each mortgage payment you make during your term.
So how much would you spend in added interest costs over a 5-year mortgage term if you opt for a cash back feature?
By crunching the numbers using a mortgage calculator, we get the following results:
|4.75% Fixed rate||5.75% Fixed rate|
|Bi-weekly mortgage payment||$628.22||$691.93|
|Total cost (principal and interest)||$81,668.45||$89,951.35|
Acquiring a mortgage with 3% percent cash back will cost you an additional $11,552.92 in interest charges ($64,812.69 – $53,259.77) over the 5-year term.
This amount is quite a steep increase to access an additional $7,200 today.
You’ll have to assess whether the cash rebate justifies the extra interest charges; otherwise, it’s wise to pass on the offer and search for alternative options.
Considerations When Choosing a Mortgage Type
Is a cash back mortgage worth getting, or should you stick with a regular mortgage instead? The answer depends on your budgetary constraints, risk tolerance, and how you plan to use the cash rebate.
Here are some factors you should consider before making your choice.
Fixed-rate vs. variable rate
A cash back feature is available only on fixed-rate mortgages, which tend to be more expensive than a variable-rate mortgage.
Ask yourself if you’d be comfortable with making higher mortgage payments.
A mortgage term refers to the period your mortgage contract remains in effect.
In Canada, mortgage terms range from six months to 10 years, with five years being the most common.
Depending on your lender’s policies, the cash back feature may be restricted to specific mortgage terms.
As a result, you might have to settle for a different term than the one you intended to sign up.
Also, keep in mind that a shorter mortgage term translates to larger mortgage payments.
In comparison, a longer mortgage term results in smaller payments.
Plans for the cash rebate
How will you utilize the money you receive from your lender?
It may be worthwhile to allocate the funds to some renovation projects or upgrades.
The appreciation in your home’s value could potentially offset all or most of the extra interest charges you incur from the higher rate set on your mortgage.
You could also use the funds to expunge high-interest debt you’ve been carrying for years, which can net you meaningful savings in interest charges.
On the other hand, if you anticipate spending the money frivolously, a cash back mortgage isn’t a wise choice due to the extra interest your mortgage will accumulate.
If you cancel your cash back mortgage contract before your term expires, you might have to pay back all or a portion of your cash rebate.
Frequently Asked Questions
- Is a cashback mortgage a good idea?
Choosing a cash back mortgage can be a shrewd move, but only if you’re getting a favourable deal (i.e., the premium added to your interest rate is low), and you plan to use the funds wisely.
Contributing the money to a significant home renovation could enhance your property’s value. You can also use it to pay down high-interest debt, saving a considerable sum in interest charges in the process.
- Do you pay tax on mortgage cashback?
No, the money your lender provides you through a cash back mortgage is yours to keep tax-free. There’s no requirement to declare it as income on your tax return.