A lender is offering a 7% cashback up to a maximum of $50,000 on a 7 year term mortgage at an annual interest rate of 7.4%. How would you be able to compare this 7% cashback mortgage with a competitive mortgage from another Bank?
Let us use the maximum mortgage possible as an example; that is $50,000/.07 = $714,285.71
The monthly payment would be $5,180.60 for a 25 year amortization period. Use the $50,000 cashback to immediately reduce the mortgage to $664,285.71 and keep the payment the same. After 7 year term (84 months) the balance owing the bank would be $539,188.50
Pretend you are going to borrow the full amount of $714,285.71 at 7.4% for 25 years resulting in a monthly payment of $5,180.60
Using the down arrow keys in the Annual Interest Rate input box in the CALCULATOR, reduce the interest rate in clicking in increments until the balance at the 84th payment in the SPREADSHEET below is with in a dollar or so of the $539,188.50
If the lender wanted to keep it simple they could have offered you an initial rate of 5.9347% (for a 7 year term rate) instead of 7.4% with a 7% cashback. That would have made it easy for you to shop around and compare current mortgage interest rates. And yes it is all about interest rates period! All the other features are irrelevant as most lenders offer variations of the same features. The purpose of the lenders exercise is to play on your lack of mathematical training. It is all a game and if you don’t know the rules and how to play the mathematical mortgage game … you lose!
The alluring $50,000 upfront cash back enticed you to sign on and if for any reason you need to exit the mortgage before the term expires because rates drop below 7.4% (but not below 5.93%) you must pay an interest rate differential “penalty” based upon 7.4% and a prorated percentage of the upfront cash back.
This is the opposite of the “points” system in the USA where borrowers pay up front money to get lower initial interest rates. The concept is the same,… fooling novice borrowers because they cant do the math.