Most lenders haven’t offered cash back mortgages (known as free down payment or zero down payment) for quite some time, but come Sept. 14th, they will no longer be available at Scotia Bank either leaving only National Bank as a last source for them. Reps at National Bank still haven’t announced when they will no longer accept those applications, but the cash back mortgage only has life until Oct. 31st.
Cash back mortgages have been around for many years, helping out first-time buyers able to purchase homes without a down payment. Here’s how it works. Since government regulation stipulates that consumers must have a 5% down payment to purchase a home, lenders have gotten around that by providing you with the 5% down payment. You never actually see the cash, the funds are provided to the lawyers at closing and they funnel the money to where it’s allocated, in most cases the seller.
Since the lender is providing you with the down payment, they still need to collect those funds back from you. The nice thing is they don’t set you up with another loan, but do have to charge a higher interest rate to collect their funds back. For instance, if you were to buy a home today and saved up your own down payment or had it gifted from family, most lenders would be able to offer you between 3.09-3.29% rate. With cash back mortgages, lenders have to charge a higher rate (to get their down payment back) which is typically the posted rate which is set by the Bank of Canada and is currently 5.24%.
Simply put, the cash back mortgages allow you to buy a home now, but will cost you more in interest charges over the first five years, but those charges are hopefully offset by a home that increases in value.
The payout penalties are the same as your regular wholesale mortgage, however there’s a twist. Often forgotten and sometimes unexplained by the lender is the fact that the cash back portion of the mortgage would have to be paid back if the owner sells the home inside of the term of the mortgage. For instance, if you obtained a five-year cash back mortgage and the down payment you required was $10,000, if you sold your home at the mid-term point, two and a half years in, then you’d owe approximately half of the down payment back to the bank as well.
If your payout penalty was $2,500 and the balance owing on your cash back down payment was $5,000, you’d end up owing upon closing of the sale of your home $7,500. This is the part of the cash back mortgage that is least understood and explained to the consumer; I often get calls from people that weren’t explained this properly upfront.
The cash back mortgage had its place in the mortgage world, and I’m sad to see it go, but it’s not the worst thing we’ve seen in years. Reducing the amortizations from 35 to 30 years and ultimately to 25 years will have a far more reaching effect on our economy than the cancelling of the cash back mortgage. Even though Scotia Bank has removed the program, there is still National Bank that has it available, well at least until Oct. 31st at the very latest.
Jean-Guy Turcotte is an Accredited Mortgage Professional with Dominion Lending Centres-Regional Mortgage Group and can be contacted for appointments at jturcotte@regionalmortgage.ca or 403-343-1125.
