With the real estate market once again getting heated, the mortgage marketing campaigns from the financial institutions are also heating up. One of the most common of the offers tempting consumers is the offer of getting cash back for your mortgage business. This often is available for both new purchases and the refinancing of existing mortgages.
It was only a couple of years ago when this was the hottest new offer in the industry. In today’s market it seems that every other financial institution in the country is offering this cash back option.
An example of the typical cash back offer on the market is 3% cash back when you sign up for a term of 5 years. Now here is where the catch comes in. Typically when you accept this offer you are taking the cash back option in the place of a rate discount.
So what does this mean to consumers? As always I would recommend that you crunch the numbers before you jump at any of the offers on the market. In today’s market it is not unreasonable for consumers with good credit and verifiable income to command a 1% discount on closed term mortgages. Some consumers are even able to get 1.05% off posted rates on the closed term of their choice.
To see how the numbers work out, let’s take a look at a comparison between what you get from a cash back offer versus what you save with a 1% rate discount. Let’s assume that you require a new $150,000 mortgage that you plan to amortize over 25 years (the standard). Lets also assume that the posted rate on a 5-year term is 8.35%. With the cash back offer you will receive $4,500 at the time the mortgage is advanced and in turn accept a rate of 8.35%. Assuming that all you do is make your minimum monthly payment then over the term of the mortgage your total payments will amount to $70,710. At the end of the term the principal balance outstanding will be $138,736.90
If you successfully negotiate 7.35% on a 5-year term (with a 25-year amortization) then your total payments over the term are $64,994.40. At the end of your term the total principal balance outstanding is $137,158.98.
This means that not only are you making $5,715.60 less in total payments over the term, but you also have $1,577.92 less principal balance outstanding at the end. Suddenly $4,500 cash back doesn’t seem so appealing?
I still think that today’s real estate prices and low mortgage rates represent a great opportunity for home ownership. If getting 3% cash back makes the difference between you being able to afford a home and renting then I say go for it. Still, no financial decision should be made without weighing out all the alternatives. Remember: when the offer seems too good to be true – it usually is.