If you’re wondering how you can get a lower mortgage rate or cashback, keep reading!
While mortgage representatives do like working with you, they definitely wouldn’t pay you out of pocket to arrange your mortgage. Mortgage brokers or lenders give cashback as an incentive to do business with you instead of offering their clients a lower rate. If you’re short on funds, you may value the cashback more than someone who has savings and is looking to minimize their mortgage payment amount. So how do you compare a lower rate to cashback?
To keep it simple, we’re only focusing on 5-year rates, since the cost per buydown would be different for each term. As a general rule of thumb, the average cost of lowering a 5-year mortgage rate by 0.05% is about 0.20% of the mortgage amount.
For example, let’s say you’ve qualified for a $400,000 mortgage. The three offers in the chart below are of equivalent value. In example A, this is what would be referred to as “buying down the rate 10 basis points”. In industry jargon this means the rate was bought down from 2.60% (the original rate) to 2.50%.
You aren’t able to buy down your own rate or give yourself cashback, so it’s offered to you by the lender or mortgage broker. This is usually done to win business by competing on price.The lender or the broker gives up an expected portion of their commission/earnings to be passed back to you, the client.
A lower rate or higher cashback doesn’t mean a lower quality product. In fact, most of the time it’s the same product that others are offering, but at a lower price. The reason is simply because the broker/lender is accepting lower margins than their competitors are as part of their business model.
Not all cashback is created equal
Typically, when banks offer cashback with a mortgage they do claw back a pro-rated amount if you break your mortgage before your maturity date. So for example, if you got $1,000 cashback for a 5-year mortgage and switched lenders after 2.5 years, the lender may take $500 back from the cashback you originally were given. Cashback offered by brokers is typically not clawed back. In either case, always make sure to read the fine print.
More money, less problems
Just like cashback, broker commission is directly tied to the mortgage amount. This means that a broker is paid twice as much in commission to close a $800,000 mortgage vs closing a $400,000 mortgage. It’s unlikely that the amount of effort involved in doing the $800,000 is also twice as much, so they may advertise a higher rate buy down or cashback amount since the payout is larger. For those with a smaller mortgage balance, the amount of cashback or rate buydowns you’d be offered may be a lot less than what is advertised on broker websites.