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Cash Back Mortgages

Jamie David

When you purchase a home, you may find that you need some extra cash. You might want to renovate, purchase furniture or simply have a cash buffer during the first few months of homeownership. Fortunately, some Canadian lenders offer mortgages that give you a cash back rebate when you take out your mortgage.

With a cash back mortgage, your lender advances you a cash lump sum when your mortgage closes. The most common sum you receive is 5% of your mortgage amount, but it’s possible to get between 1% and 7% depending on the lender you choose.

Let’s look at an example with someone purchasing a $350,000 home and putting $70,000 down (20%). They’ve opted for a 5-year fixed mortgage rate of 3.79% offering 1% cash back.

 

Example Parameters: 

$350,000 = home value

$70,000 = down payment

3.79% = 5 year fixed rate

1.0% = cash back percent

 

Step 1 : Calculate mortgage amount

   $350,000 (home price)

- $70,000 (down payment)

= Mortgage amount: $280,000

 

Step 2 : Calculate cash back value

  $280,000 (mortgage amount)

x 1.0% (cash back percentage)

= Cash back amount: $2,800

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Lenders that offer cash back mortgages

The true cost of a cash back mortgage

It’s important to note that cash back mortgages always come with a fixed interest rate, and almost always charge a higher rate than standard mortgages. This is because lenders compensate for the additional money paid out up front by charging a higher interest rate.

Continuing with our example above, the interest rate offered on the mortgage with a 5-year fixed rate was 3.79% with 1% cash back while the lowest 5-year fixed rate on a standard mortgage (i.e. no cash-back) is 3.25%.1

 

Example Parameters: 

$49,321 = cash back interest

$42,143 = standard interest

3.25% = 5-year fixed rate

 

Step 1 : Calculate extra interest paid on cash back mortgage vs standard mortgage

  $49,321 (interest on cash back mortgage)

- $42,143 (interest on standard mortgage)

= Extra interest paid: $7,178

 

Step 2 : Subtract the cash back value from the extra interest paid

   $7,178 (extra interest paid)

- $2,800 (cash back value)

= Additional interest paid on cash back mortgage: $4,378

Even if you subtract the cash rebate amount from the extra interest you’ll pay, you’ll still pay additional $4,378 over the 5-year term to receive the additional $2,800.

 

When does a cash back mortgage make sense?

The cash rebate you receive when you get a cash back mortgage is tax-free and you can use it for any purpose. Some of the most common uses are:

  • To pay for closing costs, such as legal fees and land transfer tax.
  • To supplement cash flow during the first few months of home ownership.
  • To pay for renovations or furniture purchases.
  • To invest or put into savings.
  • To pay down high interest debt.

 

Breaking a cash back mortgage term early

In addition to paying more interest on your mortgage, there is another drawback to getting a cash back mortgage. If you refinance or break your mortgage term early, you will need to pay back a portion of your cash back rebate to your lender - some lenders even require that you pay it back in full.

Lenders have different policies regarding the return of cash back rebates that require you to either pay back a portion, or the entire sum, of the rebate if you break your mortgage term early.

For example, let’s say you took out a $300,000 cash back mortgage with a 5-year fixed rate of 5.34%, and you received a 5% cash back rebate of $15,000. Three years into your 5-year term, you decide to break your mortgage term.

If your lender requires you to pay back the entire sum, in order to break your mortgage term early you would need to return the full $15,000 in addition to your pre-payment penalty.

If your lender only requires a pro-rated repayment, you’ll want to determine how much this is. In our example, you have 2 years (24 months) left in your 5-year (60-month) term. To calculate what percentage of your rebate you would have to repay to your lender, you divide the number of remaining months in your term by the number of original months in your term:

 

Example Parameters: 

$300,000 = cash back mortgage

5.34% = 5-yr fixed rate

5%= cash back percent

 

Step 1 : Calculate cash back value

   $300,000 (mortgage amount)

x 15.0% (cash back percent)

= Cash back value: $15,000

 

Step 2 : Calculate percent of rebate to repay

    24 months

÷ $60 months

= Percent of rebate to repay: 40%

 

Step 3 : Calculate value of rebate to repay

   $15,000 (cash back value)

x 40% (percent of rebate to repay)

= Value of rebate to repay: $6,000 

The table below outlines the cash back rebate return policies of different lenders.

 

Cash Back Rebate Return Policies

 

*These lenders no longer offer cash back mortgages to new home buyers.

 

References and Notes

  1. This example uses market rates as of January 2014.

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