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If you need a quick infusion of money to help pay the many costs that come with a home purchase, a cash-back mortgage might be worth looking into.
Once finalized, a cash-back mortgage advances the borrower additional funds, which can be used to cover closing costs, moving expenses or other unavoidable charges.
It might sound like a pretty sweet deal, but the cash you get back isn’t free.
» MORE: Steps to take before buying a house
How does a cash-back mortgage 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. You can use the cash for whatever you want.
Let’s look at an example: You’re approved for a $400,000 mortgage and you arrange to get 5% cash back ($20,000). When your mortgage closes, you receive the $20,000 as a single payment. Your resulting mortgage balance would then be $420,000, although only $400,000 is registered as your mortgage. The additional $20,000 is considered a loan.
Cash-back mortgage rates
While it’s handy to get extra cash after buying a house, cash-back mortgages can charge significantly higher mortgage interest rates than standard mortgages.
The higher interest rate will be applied to the entire loan amount, not just the cash-back you receive, so the additional interest charges could be considerable.
Most lenders only offer cash-back options on fixed-rate mortgages, although a small number also offer cash-back on variable-rate mortgages.
» MORE: How mortgages work in Canada
Who offers cash-back mortgages in Canada?
Many Canadian lenders offer cash-back mortgages, from Big Six banks like RBC and BMO to B lenders like QuestMortgage.
Cash-back mortgages are easy to find, but because a lender will be taking on additional risk by loaning you more money than your mortgage requires, they’re not necessarily easy to qualify for.
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 don’t intend to rent it out.
Cash-back mortgage penalties
With most mortgages, there are penalties for refinancing or breaking your mortgage term early. If you break a cash-back mortgage, your lender may require you to pay back some or all of the cash you’ve been advanced — on top of a prepayment penalty.
Penalties vary by lender, but they’re something to keep in mind if you’re contemplating a cash-back mortgage. Ask plenty of questions so you understand your lender’s prepayment penalties before finalizing the mortgage.
» MORE: How much mortgage can I afford?
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Is a cash-back mortgage a good idea?
A cash back mortgage can be a useful option if:
- You want to finance closing costs, like land transfer taxes or legal fees.
- The home you’re buying needs major repairs or renovations.
- You need to furnish your new home.
- You have 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.
If you have a dedicated purpose for the money you’re being advanced, you’ll be less likely to put it toward something that provides less of a return on investment.
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:
Pros
- Access to cash that can be used to cover additional homeownership expenses.
- Your mortgage and the cash-back loan can be paid with the same monthly payment.
- Wide availability allows you to comparison shop and find the right rate and terms for your financial situation.
Cons
- Higher interest rates than a traditional mortgage.
- May have stricter qualification requirements.
- Penalties if the cash-back mortgage contract is changed or broken.
Alternatives to a cash-back mortgage
If a cash-back mortgage doesn’t feel like the right way to increase your cash flow after buying a home, there are other financing options to consider, including:
- A second mortgage like a home equity loan, which can turn equity into cash once you own the home.
- Personal loans, which are generally easy to find. If your credit score is strong, you could be offered a decent rate.
- A line of credit, which can be a more flexible financing option than a personal loan while offering better interest rates.
- Borrowing from your retirement savings using the Home Buyers Plan. You can borrow up to $35,000 from your Registered Retirement Savings Plan (RRSP) to help with the down payment and other closing expenses.
- A credit card, particularly a low-interest or no-fee credit card, which can give you the flexibility to cover 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 disrupt the process.
Frequently asked questions about cash-back mortgages
The money you receive from a cash-back mortgage is actually being borrowed from your lender, so it is not considered income. It’s a loan.
If there is no other way to cover the additional costs that come with purchasing a home, a cash-back mortgage can be useful. But cash-back mortgage rates can be much higher than typical mortgage rates, which means you could wind up paying much more for your mortgage in exchange for some short-term financial help.
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