Cashback mortgages have been around a long time, not quite long enough for stories of the pain related to breaking one to have circulated to great extent.
I recently attended a presentation by a lender in which several dozen Mortgage Brokers were asked if they would like to see a ‘Cashback’ mortgage product. Not a single hand went up. Why is that? The vast majority of brokers know that for the vast majority of clients such a mortgage has far greater pitfalls than benefits.
So, what is a ‘cashback mortgage’?
Eseentially it is a mortgage that is signed at a higher than market interest rate, (this would be the’give’). In exchange the client recieives a % of the mortgage back in cash at signing (for the client ‘the take’).
The % of cash back offered tends to range from 2% to 5% which can be a very attractive amount of money. The dazzle of that cash often distracts the client from the proportionately higher interest rate which effectively funnels all of the upfront cash back to the lender over the term of the mortgage…with interest.
There is no free lunch.
Even if the client can see that they are paying the funds back over time, they often are still tempted because they need that lump of cash at that familiar time in life that we all need it – Right Now!
However it is important for clients to take a step back and take a breath and look at a few statistics.
One needs first to be aware that roughly 60% of fixed rate mortgages are broken early – typically at 38 months. The deeper meaning of this relates to the type of (and size of) penalties incurred.
Understanding that 6 out of 10 people are essentially making the incorrect choice with regard to the term of their mortgage is vital, as you effectively have a 60% chance of being in that same group.
Where this really comes into play is that the bombshell is not so much that the ‘cashback’ must now be repaid, which it does either in full or pro-rated – either way a major hudle for many. After all you were paying that higher rate and additional interest all along and as it turns out it was for no gain, and an even larger loss as follows.
The real bombshell is that penalites for fixed rate mortgages are often (these days nearly always) calculated on the basis of ‘interest rate differential’(IRD) and in the case of a cash back mortgage you have opted for a higher than market rate which not increases the likelihood of an IRD penalty being triggered, but it exacerbates the size of the penalty to boot.
Anticipate a penalty of approx. 4-5% of the mortgage balance to break a 5 year once you are 30 months in, in addition to repaying the ‘cashback’.
Bang, Bang, you get thumped twice. Not nice.
These products are essentially the lender loaning you more money at a higher rate. There are better ways to do this as within this transaction lurks a major bombshell.
The Bank is not your ‘friend’, there is no ‘relationship’. It is a business that makes staggering profits for a reason.
In Conclusion, buy Bank Shares (they will continue to find more profitable way to separate us from our cash) and enlist an independent Mortgage Broker to walk you through the ups and downs of all the products out there.
There is no free lunch.
Dustan Woodhouse
AMP – Accredited mortgage Professional