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You have options when it comes to mortgages, and that includes whether to opt for an open or closed mortgage. Each one is designed with a specific borrower in mind, which is why you’ll need to determine what your particular needs are before choosing one over the other.
Let’s take a look at each mortgage type in detail to help you decide which one might suit you best.
A mortgage is a type of loan that homebuyers use to finance the purchase of a home. The home itself is used as collateral against the loan. This allows the mortgage lender to repossess the property in the event that the borrower defaults on the loan payments.
The entire loan amount must be paid back in full by a certain date via installment payments, which include the loan amount plus interest.
Amount | Rate | Availability | Products | ||
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One particular aspect to consider when applying for a mortgage is whether to choose an open or closed mortgage. Each has its own advantages and disadvantages, so it’s important to understand what each mortgage type is and assess it based on your specific situation.
Closed mortgages typically come with terms ranging from anywhere between 6 months to 10 years. They also usually have lower interest rates than open mortgages. Closed mortgages are generally more popular than open mortgages among homebuyers in Canada because most prefer to have a longer time period within which to pay off their mortgage. They also come with fixed monthly mortgage payments, which makes budgeting much easier.
Closed mortgages have a lot of rules and restrictions, you generally cannot pay off your mortgage in full before your term ends without a penalty. You also can’t renegotiate or refinance the home loan before the end of the term. Paying the mortgage off early will subject you to an early repayment penalty fee, which can cost a few thousand dollars.
That said, some closed mortgages may come with a prepayment contingency. In this case, you may be allowed to increase your monthly payments by a certain amount or have the opportunity to make one lump sum payment every 12 months if you have the cash to do so.
Open mortgages typically have shorter terms of 5 years or less, though the lender doesn’t have to hold the loan until it matures. Unlike closed mortgages, open mortgages allow borrowers to fully repay the mortgage loan amount, renegotiate the terms, or refinance the loan at any time with no penalties.
Borrowers may find this option more attractive if they believe they may be able to come up with large sums of money from time to time to put towards the principal portion of their mortgage. By doing so, borrowers may be able to pay off their mortgage early, which not only reduces their overall debt but also saves them money in interest overall.
The interest rate associated with open mortgages is usually higher than closed mortgages in exchange for greater flexibility. With an open mortgage, you can expect to pay the prime rate plus a certain premium.
Main advantage: Payment flexibility
The biggest difference between open and closed mortgages is the level of flexibility between the two. Namely, closed mortgages are not as flexible because they cannot be paid off early without a prepayment penalty fee involved.
While you might be able to repay your mortgage early on a closed mortgage, you can’t do so without being slapped with a penalty fee for doing so. The exact amount you’ll have to pay to cover prepayment penalties on closed mortgages depends on whether your mortgage rate is fixed or variable.
On a fixed-rate mortgage, the prepayment penalty fee can be one of two things, whichever is greater:
On a variable-rate mortgage, the prepayment penalty fee is typically 3 months of interest.
As mentioned, you’ll be more likely to have a higher interest rate with an open mortgage than with a closed mortgage. But the exact rate you’re charged will also depend on whether you opted for a variable- or fixed-rate mortgage.
The rate on a variable-rate mortgage, whether open or closed, fluctuates at various points throughout the mortgage term based on market conditions. This is because variable rates are based on the prime rate.
Check out what is an interest-only mortgage.
The rate on a fixed-rate mortgage remains the same throughout the mortgage term, regardless of what’s happening in the market.
Borrowers who might be uncomfortable choosing between open and closed mortgages may have the opportunity to take out a “convertible” mortgage, which are fixed-rate closed mortgages with a very short term.
With a convertible mortgage, you have the option to make larger prepayments when your mortgage is up for renewal without having to pay any penalties since the term renewal will be a lot sooner than a typical mortgage term.
You’ll also be free to convert your short-term convertible mortgage — usually about 6 months — into a longer-term mortgage with no penalties. That said, there could be a fee to convert your mortgage into a longer-term one.
You might want to consider a convertible mortgage if you have intentions of selling your home within 6 months or if you come across a large sum of money to be able to put towards your mortgage and pay it off early.
This option is also more attractive if interest rates are expected to decline within the next few months. In this case, you’ll be free to lock in a lower interest rate when your 6-month mortgage term ends.
Your decision to choose an open or closed mortgage should be based on your current financial situation, as well as where you see yourself in the foreseeable future. While flexibility might not be too important for some borrowers, it might be a must-have for others.
There are clear benefits to both open and closed mortgages, but those perks only apply in certain scenarios. Assess your financial situation and where you foresee yourself in the near future before deciding which type of mortgage to apply for.
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
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Loans Canada is pleased to announce it placed No. 131 on the 2022 Report on Business ranking of Canada’s Top Growing Companies.
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