Some bank offers should be refused
Lenders’ cash back mortgage deals come with steep costs
It’s the last refuge of those who don’t have money, but who still want to own a home.
The banks have long used the offer of giving cash back as a lure to attract customers, many of whom can’t come up with the minimum five per cent down payment demanded under government-backed mortgage insurance rules.
The deal is simple. The bank gives you cash up front to use however you want, except as a down payment.
The price of the upfront cash is a much higher interest rate — usually the posted rate, which is almost two percentage points higher than you might get negotiating.
It’s a costly move when considered over the life of a five-year mortgage. My bank says you can get $20,000 up front on a $400,000 mortgage, based on a five per cent cashback mortgage. Based on monthly payments at the current posted rate of 4.99 per cent, that mortgage will cost you $93,422.91 in interest over five years. The same mortgage will cost you $55,288,48 in interest at 2.99 per cent — the going rate in the discount market.
You are paying almost $40,000 more in interest — the difference between the posted and discount rate — to get $20,000 today. Even when you consider the money is in presentvalue dollars, it’s pretty clear why this type of offer is not a great deal for the consumer and is being discouraged. You’re not supposed to use it for a down payment, but it finds its way there anyway, according to many people in the industry.
This past week the Office of the Superintendent of Financial Institutions reiterated it doesn’t like the practice at all, recommending mortgagedefault insurers not underwrite loans that use cash back for a down payment.
Draft guidelines on residential mortgage insurance underwriting practices issued by OSFI included a section on down payment.
“Incentive and rebate payments (i.e. cash back) should not be considered part of the down payment,” said the regulator.
In cases in which people don’t use their own equity and opt for non-traditional sources as a down payment, the regulator seems to want federally regulated mortgage insurers to consider that a risk and charge larger premiums.
Led by Canada Mortgage and Housing Corp., the crown corporation that has the largest position in the market, all mortgage-default insurers will be raising their premiums May 1.
Even though you supposedly need to have five per cent down, you are allowed to add the cost of the mortgage insurance premium to your loan. Premiums are as high as 3.15 per cent for a mortgage with five per cent down, but, not to worry, you can still add that to your loan, which will take you to 98.15 per cent of the value of your home.
“I think you want to have some savings mechanism in place to make sure you have some sort of down payment,” says Calum Ross, a Toronto-based mortgage broker, who is not a supporter of cashback mortgages. “I think it’s a fundamental risk to the system if you don’t have any skin in the game.”
Rob McLister, editor of Canadian Mortgage Trends, says there’s not much banks or insurers can do if consumers are coming up with their five per cent through other means, such as borrowing from family or putting it on a credit card.
“Lenders have been giving cash back, it’s kind of a loophole to the 100 per cent financing rule prohibition,” McLister says, referring to a previous rule change that demanded the minimum five per cent down.
“But you can still get that down payment by borrowing at 18 per cent on your credit card, if you want to.”
McLister says credit unions, which have been allowed to do 100 per cent financings because they are not federally regulated, will no longer be able to provide those loans if they are to be covered by government-backed mortgage insurance.
Benjamin Tal, deputy chief economist with CIBC, says some people will always find a way around rules.
“You can get a loan from a parent and call it a down payment (and then pay it back). You can never underestimate the creativity of people,” says Tal.
Consumers should resist the lure of cash up front from lenders when taking out a mortgage. It’s better to take the long view and save for a down payment.