Buying a home is the biggest purchase many Canadians ever make. Even after saving a down payment and getting approved for a mortgage, there are other expenses to think about, like closing costs, moving expenses, new appliances or furniture, and any immediate repairs the home may need. By allowing you to borrow more than the house’s purchase price and providing you with a lump sum of cash on closing day, a cash-back mortgage can help you cover these expenses, and more.
What is a cash-back mortgage and how does it work?
With a cash-back mortgage, you take out a loan for more than what’s required to purchase the house. The excess can be a fixed amount, like $5,000, or percentage-based, often between 1% and 7% of the purchase price. That amount is provided to you as a lump sum when your mortgage closes, and you can use the cash for whatever you want.
Let’s look at an example. Say you’re approved for a $400,000 mortgage and you arrange to get 5% cash back. When your mortgage closes, you’d receive $20,000 in cash back. Your resulting mortgage balance would then be $420,000, although only $400,000 is registered as your mortgage. The additional $20,000 is a loan.
While it’s handy to get extra cash after buying a house, cash-back mortgages come with drawbacks, such as higher interest rates than standard mortgages and no option to choose a variable-rate mortgage.
» MORE: How mortgages work in Canada
How to get a cash-back mortgage
Many lenders offer cash-back mortgages, including some of Canada’s big banks and financial institutions.
To qualify for a cash-back mortgage in Canada, you’ll need to meet the requirements set out by the lender. Typically, these include:
- Reliable employment where you earn a salary or are paid by the hour. Self-employed people are not usually approved for cash-back mortgages.
- A credit score of at least 650.
- Plans to be an owner-occupant of the home, meaning you you don’t intend to rent it out.
Note that with a cash-back mortgage, there are penalties for refinancing or breaking your mortgage term early. Many lenders will require that you pay back all or some of the cash on top of a prepayment penalty. Penalties vary by lender, but it’s something to keep in mind if you’re contemplating a cash-back mortgage. Ask plenty of questions so you understand your lender’s policies before finalizing the mortgage.
» MORE: How much mortgage can I afford?
Is a cash-back mortgage a good idea?
A cash back mortgage can be a good option to consider if:
- You want to finance closing costs, like transfer taxes or legal fees.
- You know the home needs major repairs or renovations.
- You need to furnish your new home.
- You may need to supplement your cash flow for the first couple of months after buying a home.
- You need extra cash to cover the costs of moving.
- You want to pay down high-interest debt or student loans.
Pros and cons of cash-back mortgages
Cash-back mortgages might seem like a great idea, but they’re not right for everyone. Here are the main pros and cons to weigh:
- Quick cash in your pocket after closing.
- Pay your mortgage and the cash-back loan with the same monthly payment.
- Plenty of options on the market so you can comparison shop for rates and terms
- Higher interest rates than a traditional mortgage.
- May have stricter qualification requirements.
- Hefty penalties if the cash-back mortgage contract is changed or broken.
- No variable-rate option.
Alternatives to a cash-back mortgage
If you’re looking for ways to increase your cash reserves after buying a home, but a cash-out mortgage isn’t a good fit, there are other financing options you can consider.
Credit card: A low-interest or no-fee credit card can give you the flexibility you need to cover things like moving costs or furniture purchases, and pay for them over time if needed. Be sure you wait until after your mortgage closes to apply, however, to avoid fluctuations on your credit report that might interrupt the process.
Second mortgage: A home equity loan can allow you to turn equity into cash, once you own the home.
Line of credit: A line of credit is a very flexible option for borrowing money and generally offers better interest rates than a personal loan.
Personal loan: Personal loans are pretty easy to find, and if your credit score is good, you should be able to find decent rates.
Borrow from RRSPs or investments: Borrowing from your retirement savings or investments isn’t ideal, but it’s definitely an option at your disposal. The Home Buyers Plan allows you to borrow up to $35,000 from your RRSP to help with the down payment and other closing expenses, for example.