I was in the bank the other day and saw a bright pink sheet of paper advertising the latest mortgage rates. What struck me was the offer for 3% cash back on your mortgage, in exchange for a measly 0.6% increase on your mortgage rate. Hey, it’s only point six percent, surely that can’t be a lot of money, right?

Wrong. Lets look at the math, courtesy my local copy of Excel:

First we start with a mortgage amount; in this case we will use a nice, round number: $200,000. Next we need a mortgage term: 25 years. Finally we need an interest rate; the bank was advertising 4.6%.

I am going to make the huge assumption that the bank was offering to let me lock the interest rate in at 4.6% for the full 25 year term. With the extra 0.6% our interest rate when taking the 3% cash back is 5.2%.

First the 4.6%:

Amount: $200,000
Term: 25 Years
Payment: $1123.05 per month
Total Interest: $136,914.23

Now at 5.2%:

Amount: $200,000
Term: 25 Years
Payment: $1,192.60
Total Interest: $157,780.91

Yowza, that’s compound interest at work. What if we just added $6000 to the 4.6% scenario?

Amount: $206,000
Term: 25 Years
Payment: $1,156.74
Total Interest: $141,021.66

You still save thousands of dollars over the cash back option. The bank is not doing you a favor by offering you cash back. The bank may try to show how it is free money to improve or furnish your new home, but it isn’t a good idea. If you need such money, look at increasing the size of your mortgage or a second loan, but don’t take the cash back option.

This entry was posted on Sunday, June 12th, 2005 and is filed under Banking, Home Finance. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.