Mortgage cash rebates can save you money

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Big banks have been throwing money at mortgage shoppers for years, using cash bonuses as incentives to win their business.

But, in recent years, banks have upped the ante. Depending on the lender, you can now score cash rebates up to $4,000, potentially more if your mortgage is big enough.

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These deals differ from the “cashback mortgages” of old, which usually came with higher rates. In today’s hyper-competitive market, cash offers can be found even on bargain-basement discretionary rates — those unadvertised offers that banks give well-qualified borrowers who negotiate.

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Now, banks aren’t doling out cash simply from the goodness of their hearts. They want to see borrowers commit to them in exchange for these sweeteners. That means you usually have to pick a term of three to 10 years. If you want a short fling in a one- or two-year fixed, that’s an affair the banks won’t subsidize.

On that note, an abnormal share of mortgage shoppers has been taking one- and two-year mortgages. These shorter terms offer the flexibility to reset to a lower rate sooner. Many find that appealing, given expectations the Bank of Canada will dial back its tough love on monetary policy this year.

Others, specifically conventional borrowers, want a short stint because variable-rate discounts are worse than normal. They plan to take a one- or two-year and then renew into a fatter variable discount in 2025 or 2026.

By that time, if history is a guide, variable pricing could potentially improve from roughly prime minus 0.60 per cent today to somewhere around prime minus 1.00 per cent.

Cash rebates alter the math

This desire to game the rate market is leading some to lock in for just a year or two, meaning they’re foregoing cash rebates. But borrowers beware: dismissing cashback offers may thin your wallet.

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The reason is, cash rebates can materially lower one’s overall borrowing cost. That can make a longer term more cost-effective, even if you prefer a shorter commitment.

On a $500,000 three-year mortgage, for example, a bank might put $2,500 cash in your pocket. Opt for a one- or two-year term instead, and the cashback vanishes faster than a toupee in a convertible.

But let’s dissect the numbers further.

Imagine that you’re torn between the following two mortgage options:

Option #1:  A 6.04 per cent two-year fixed with no cash back — which you expect to renew into a prime minus 1.00 per cent variable in 24 months.

Option #2:  A 5.49 per cent three-year fixed with $2,500 cash back. Now assume you take a 25-year amortization on that $500,000 mortgage, make no mortgage changes for three years, and the overnight rate drops eight times, with one 25 bps cut at every other Bank of Canada meeting, starting this July.

If you simulate all this to estimate your expected borrowing cost, here’s what you’ll find.

With no cashback, the two-year fixed saves about $200 on paper after three years (including that one year in the variable rate after renewal).

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A few hundred bucks is not exactly the stuff of financial legends.

Moreover, for all we know, renewal rates may be higher than expected in two years. So there’s risk in that two-year term.

Once you factor in the cashback, the optimal mortgage becomes much clearer. On paper, at least, the hypothetical lowest cost of borrowing shifts from the two-year fixed to the three-year. In short, the cash bonus is equivalent to getting another 19 bps off the three-year fixed interest rate.

Now, remember the part above about making no mortgage changes for three years? We make that assumption because, if you do break the mortgage early, banks typically claw back some or all of the cash rebate. That’s in addition to any prepayment penalties that may apply. Penalties and clawbacks can turn a sweet mortgage deal sour in a hurry.

The gist is this. For borrowers who ride their mortgage to maturity, cash rebates can turn the tables on which term is best mathematically. If you’re debating between a variable or a one-, two- or three-year fixed, calculate your total expected cost of borrowing over three years, or ask a mortgage adviser to do it for you. In cases where short- and longer-term mortgages have similar projected borrowing costs, the cash may be king.

Robert McLister is a mortgage strategist at FixedorVariable.ca and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.

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