Lender cash back can work for some but doesn’t come without cost
I had the opportunity to help a few clients purchase a home who had the interpretation they would not be able to enter the housing market for another year. These clients had solid credit, good job stability but they lacked one of the most common first time buyer requirements, a down payment.
In these, like all cases, we explored every option available for a down payment ranging from grants, HBP (RRSP Home Buyers Plan), a gift from family, borrowed funds (Line of Credit, etc.) but none were feasible for clients.
This left us with one option which only a couple banks offer, a “Lender Cash Back”. This specific program covers the 5% down payment which is paid from the bank and they also covered an additional .5% to help with closing costs or to help increase the clients minimal savings. As with anything today, this is not free. The bank increases your interest rate in order to make back the down payment over 5 years. Today you can get a 5 year fixed rate at 3.65%. With this program you get the posted rate which today is 5.39%.
So in all cases the bank makes back the full down payment and you end up paying less towards your principle (along with higher monthly payments) due to the higher interest rate. In some scenarios it can get you into a home sooner than expected but I encourage clients to explore all other options before settling for a Lender Cash Back.
The mortgage you choose should always suit your needs, this is just another option available in the market today that not all are aware of. Please feel free to comment or call me at 306-260-9918 to ask any questions you may have.
Have a great weekend.
Riel Syrenne
The Mortgage Group
5 comments so far. We'd love to hear your thoughts.
September 3rd, 2010 at 5:37 AM
“The bank increases your interest rate in order to make back the down payment over 5 years. Today you can get a 5 year fixed rate at 3.65%. With this program you get the posted rate which today is 5.39%.”
That sure is a far cry from “free”! That’s such a huge amount of money over the term of a mortgage, I’d think it would be essential for any buyer (or their Realtor or mortgage professional) to calculate the actual dollar amount they’re spending in order to get this mortgage product. I know a lot of people don’t understand differences in percentages so much as they understand plain ol’ dollar signs, but 1.74% will cost the average home owner many thousands of dollars in only a few years. Yikes!
September 3rd, 2010 at 11:39 AM
Thanks for the comment ‘lawtalkingguy’,
I ran some numbers based on a $200,000 home purchase so we know exactly how the numbers effect a client going into this type of mortgage. Here are the numbers:
Using the 3.65% vs 5.39% over a 5 year term you end up paying $12,411 more in total payments. Keep in mind the bank offers you 5.5% cash back at closing so if we subtract the amount they provide up front ($11,000) we find you only pay an additional $1,411.
With that said you will obviously pay more to interest than principle with an increased interest rate so I ran those numbers as well. At 3.65% you will be left with a mortgage balance of $180,728.65 after the 5 year term, $4,268 lower than the $184,996.28 balance you are left with using the 5.39% rate.
I hope this helps!
September 3rd, 2010 at 12:59 PM
Riel, in your example, the homeowner essentially payed an additional $5679 ($1411+$4268) for a 5-year loan of $11,000. This works out to an effective interest rate of 8.7% on the $11,000 loan. They would be better off borrowing the downpayment with a line of credit at a lower interest rate, but I guess it beats using a credit card
Including 2.75% for CMHC insurance, they are effectively paying an additional $11,180 in extra “risk” fees since they are not willing to wait until they save up a downpayment.
September 3rd, 2010 at 4:17 PM
Thanks Travis,
That’s exactly right, your left with an added cost of $5,679 in total. In these cases savings were minimal and borrowing from any source was just not an option or else we definitely would have went that route. I consider the ‘Lender Cash Back’ as a last resort and in these cases it was the clients only option.
In regards to the CMHC Insurance. The difference between a saved down payment, & in this case a borrowed down payment, is a premium difference of 2.75% vs 2.90% (based on a 25 year amortization). So based on a $200,000 purchase price, you’re looking at a premium of $5,225 if you save your own down payment. And a premium of $5,510 if you use the Lender Cash Back. To avoid any CMHC fee’s with any bank they still require the full 20% down.
So to break everything down, you pay an additional $1,411 in payments, $4,268 less on your principle & $285 more in CMHC fee’s totalling a cost of $5,964 over the the length of a 5 year term. So is the down payment free? Not at all
September 5th, 2010 at 9:01 AM
Thanks Riel,I never thought about the extra interest you’d pay. 5600 is a lot different than the 1400 I had thought.
Thanks