How Do Cash-back Loans Work in a Mortgage?

Buying a house is among the largest purchases an individual will make in their life. The costs can be enormous. Saving for the down payment, maintenance, moving expenses, closing costs, and updating furniture and appliances are among the many associated expenses. 

If you think you might need a little more cash somewhere along the way in your home ownership journey, then consider utlizing a mortgage or refinance that gets cash back in your pocket. You can do this through two ways: a cash-back loan or a cash-back refinance loan.

If you are looking to buy a home and find yourself in need of supplemental cash right away, a cash-back mortgage can be a good option. A cash-back mortgage is when a lender will give you a lump sum of money, usually between 2% and 7% of the property’s value, when you close the mortgage. These additional funds can help you cover many of the excessive expenses associated with home buying. 

How Does it Work?

You take out a loan that is in excess of the purchase price for the property. It can be a fixed amount or percentage-based, with most lenders dishing out a sum of money between 1% and 7% of the value of the home. You receive the funds when you finalize your mortgage and the cash can be used however you like.

For example:

Let’s say you are looking at a $300,000 dollar home, but it looks like it might need some renovations. You apply and get approved for a $300,000 mortgage with 6% cash back. This means along with the mortgage, you will get a loan of $18,000. Your mortgage balance will be $318,000, but the additional $18,000 will be a loan and not registered as your mortgage. Getting this package would allow you to purchase the home and pour an additional $18,000 worth of renovations into it.

Many banks and financial establishments offer cash-back mortgages, but you may need to meet certain criteria. You’ll need a good to excellent credit score and proof of steady employment. You may also need to prove that you plan to occupy the house once purchased, not just rent it out.

This sounds like a great deal and a fantastic way to cover additional expenses when buying a home. But there are certain downfalls of getting a cash-back mortgage to be aware of.

Among the most common drawbacks you will find is that cash-back mortgages often have higher interest rates of those of a traditional mortgage. And, as mentioned, you may have to meet a higher standard of requirements in order to qualify. 

For example, many self-employed people may find it difficult to get approved for a cash-back mortgage. There is usually no option to choose a variable-rate mortgage and there can also be penalties for trying to refinance or breaking the terms of the mortgage early on.

With these risks in mind, it’s best to consider a cash-back mortgage in only certain situations. If you want to furnish your new home, pay for moving expenses, renovate, or finance closing costs upon finalization of the home’s sale, then a cash-back mortgage is a good solution.

Now let’s Turn to a Cash-Back Refinance Loan 

This is when you already have a mortgage and want to get cash back from the equity you’ve built towards your home.

A cash-back refinance involves replacing your current home loan with a bigger mortgage, allowing you to access the difference between the two in cash along with getting new terms of the mortgage, such as the interest rate or loan term. This a great option if you want to take advantage of the equity you’ve built up towards your home to cash out and use those funds in a variety of ways.

For example: 

let’s say your home is currently worth $300,000 but the remaining balance you have on your mortgage is $100,000. This means you have $200,000 in home equity. In a cash-out refinance, banks will usually lend out around 75% of a homes value. In this case, that means $225,000. You could refinance and get a loan for this $225,000, paying off the $100,000 balance left on your mortgage and giving you $125,000 in cash.

This remaining cash balance can be used in any way you see fit. For example, many people who who use a cash-out refinance use the funds to renovate their home, further upgrading the value of the property, or pay for a child’s tuition.

To qualify for a cash-out refinance, you’ll need to meet certain criteria. A good to excellent credit score will likely be needed and can help you get a more favorable interest rate. You’ll usually need to have paid off at least 20% of the home’s current value – or 20% in home equity – to get approved. Your debt-to-income, or DTI, will also be scrutinized. Your DTI is your monthly debt payments divided by your monthly income. The lower your DTI, the better chances you have of getting approved.

One of the major drawbacks of a cash-out refinancing is that since your home is the collateral for the mortgage, you risk losing your home if you can’t make the payments. This can be more problematic if the terms of the new mortgage have a higher interest rate or fees. Your new interest rate could be higher or lower than the one on your original mortgage depending on the conditions of the credit market at the time of refinancing. Make sure you do your due diligence to see if it’s a good time to refinance and calculate how much interest you would pay over time on the loan.

With all the risks in mind, if you find yourself in cash at the outset or somewhere along the way in your home ownership journey, a cash-back mortgage or a cash-out refinance can be good solutions for getting more money in your pocket. In either case, make sure to practice good financial habits to pay your mortgage payments in full and on time.