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What is a Cash Back Mortgage and How Does it Work?
A cash back mortgage is a mortgage where the lender provides you with a cash rebate on your mortgage upon closing. The amount of cash you’ll receive is calculated as a percentage of your mortgage loan amount. The amount of cash back you’ll get as part of a cash back mortgage typically ranges from 1% to 7% of the mortgage amount (5% tends to be the most common). It’s a good idea to shop around to maximize the amount of cash back you’ll receive.
Why You Might Choose a Cash Back Mortgage
Cash back mortgages make the most sense for first-time homebuyers purchasing homes for less than $500,000 with a minimum 5% down payment.
When buying a home, it’s easy to overlook closing costs, especially as a first-time homebuyer. Closing costs typically add up to between 1.5% and 4% of the purchase price of a home. As the borrower, you’re responsible for covering them out of your own pocket. Your lender won’t cover them. The great thing about a cash back mortgage is that you can use the cash to cover closing costs, such as home inspection fees, real estate lawyer fees, land transfer taxes, new furniture and movers.
But you don’t have to use the cash back towards your closing costs. You can use it as you see fit. For instance, you could use it towards home renovations or building an emergency fund.
Cash back mortgages do have their shortfalls though. Before signing up for one, it’s important to ensure you fully understand how it works.
They say there’s no such thing as a free lunch when it comes to money and the saying holds true for cash back mortgages. Getting cash back on your mortgage may sound like a great deal, until you realize that you’re most likely paying a higher mortgage rate in exchange for the cash back.
Although you may save money up front, you’ll most likely end up paying more by way of mortgage interest over the life of your mortgage, negating any savings you got from the cash back.
Not all lenders offer cash back mortgages. Less competition means the mortgage rates tend to be higher as well.
Thinking about using the cash back towards your down payment or deposit? Think again. Cash back mortgages can’t be used towards your deposit and down payment. The lender will want you to come up with those funds on your own.
Cash back mortgages can be costly to break; more costly than a standard mortgage. Besides paying the penalty associated with breaking your closed mortgage, you may also be required to pay a portion or all of the cash back you received, depending on when in your mortgage term you break it.
The bottom line is that cash back mortgages can be good if you’re getting a great mortgage rate, otherwise you’re probably better off sticking with a standard fixed or variable rate mortgage.
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