Imagine you are buying your first house. Your mortgage broker presents you with a couple of interesting deals, but one, in particular, is as shocking as it is satisfying. What is that deal? It is what the industry calls a cashback mortgage. It is a mortgage that might seem too good to be true.
A cashback mortgage works a lot like a cashback offer from a car dealer. If you agree to take a mortgage from the lender making the offer, you will receive a certain amount of cash at closing. These kinds of mortgages are quite popular in the UK, the US, and many other countries.
The question to ask yourself is whether or not a cashback mortgage is really a good deal. There is a lot to think about, so don’t just rush and take a deal because you want a little spending money to buy yourself a few housewarming gifts.
How Cashback Mortgages Work
The first and most important thing to understand about a cashback mortgage is that the lender is not giving you free money. They are not gifting you with cash because they feel like being nice. You might take the cash now, but you will pay it back over the life of your mortgage. More importantly, you will pay it back at the same interest rate that applies to the principal.
A cashback mortgage is pretty simple to understand. The lender offers you a certain amount of cash in exchange for obtaining your mortgage through them. Let’s say £1,000 for the sake of this discussion. You will get that money from the bank or your solicitor once you close on the house.
If you were to do all of the mathematical calculations, you would discover that the £1,000 has been added to the amount you borrowed. So your cashback is more or less a personal loan tacked on top of your mortgage. This does not necessarily make cashback mortgages a bad thing. They are neither good nor bad in and of themselves. You have to weigh the pros and cons to figure out if a cashback mortgage is right for you.
Now let us move on to talking about some of the considerations. As you continue through this post, you might want to think about some further reading on cashback mortgage deals. There is plenty of information online. If you are working with a broker, do not be afraid to ask him or her for more information.
Consider the Interest Rate
Interest is the single biggest cost of borrowing. That’s why it is such a crucial factor when your mortgage broker shops around for deals on your behalf. When it comes to cashback mortgages, they are often put on the table with slightly higher interest rates. This is something you have to think about.
The difference could be as little as one quarter of one percentage point. For example, let’s say you have the choice between a cashback mortgage at 2.5% and a standard mortgage at 2.25%. The difference will not translate into much as far as your monthly payments are concerned, but interest adds up over time.
Run the numbers and it might turn out that the cashback mortgage costs you less than £10 more per month. Then calculate the interest over the life of the mortgage. You are likely to see that you will save thousands by taking the standard deal. Now you have to ask yourself whether getting some extra cash is worth paying more interest.
Other Things to Consider
Interest is an important thing when you are looking at cashback mortgages. But it is not the only thing. There are other things that might influence your decision:
- Your Cash Position– You might legitimately need some extra cash at closing to cover for the fact that you have drained your bank account to buy the house. Receiving cash at closing might be a necessity just to keep you afloat until your next pay cheque.
- Uses for the Cash– You need to consider what you would use the cash for. There may be a legitimate expense you feel warrants the extra cost of a cashback mortgage. That’s fine, just as long as you understand the implications.
- Immediate Need– Finally, even if you decide you need the cash from the cashback mortgage, do you really need it right away? If you don’t, you could take the standard mortgage and put the difference in payments into a savings account.
Cashback mortgages are yet another option that lenders offer in order to differentiate themselves from the competition. They are neither good nor bad in and of themselves. Like everything else in the financial services sector, every cashback mortgage has to be considered on its own merits. A cashback mortgage may very well be your best option. But it might not be. You and your broker will have to decide that together.