24 May
What is an open mortgage?
The concept of an open mortgage refers to the ability of being able to pay off the whole mortgage balance in full or in part at any point in time. Contracts established for open mortgages can be renegotiated or refinanced without incurring any penalties. Moreover, borrowers who have open mortgages have the ability to convert them to another term without any prepayment charges.
It is important to note that the open mortgages are generally shorter than closed mortgages and they range from six months to five-year terms. Although open mortgages are not popular in Canada, they are still a viable option for borrowers who aim to pay off their mortgage earlier or if they have plans to deviate from the standard, longer-term repayment schedule. Nevertheless, interest rates are usually high for open mortgages as compared to closed mortgages. In most cases, borrowers would have to pay the prime rate along with a substantial premium.
What is a closed mortgage?
Compared to open mortgages, closed mortgages are less flexible and have more restrictions. If a borrower is applying for a closed mortgage, then they are not allowed to refinance or renegotiate the terms without being penalised, and they cannot pay off their mortgage loan early. However, the benefit of having a closed mortgage is that the interest rate is usually lower than for an open mortgage.
There are some situations where having a closed mortgage may offer certain privileges to the borrower, such as a regular payment increase, or being able to pay off a portion of the mortgage once per year. Because the majority of the Canadian citizens do not aim to pay off their mortgage within a short period of time, they are more inclined to have a closed mortgage rather than an open mortgage.
How to Choose the Right Mortgage?
If you are unable to decide whether to select an open mortgage or a closed mortgage, it is essential to consider the following factors:
- You are about to sell your home: You may want to consider opting for an open mortgage if you are aiming to pay off your mortgage with the proceeds of selling your house. If you pay off the whole closed mortgage, you will likely incur a significant prepayment penalty.
- You are about receive an inheritance: If you are about to receive an inheritance in the near future, then it would be beneficial for you to consider paying a lump sum payment with little or no penalty.
- You started earning more income: If your monthly income has increased, then having an open mortgage will allow you to pay off as much as you want at any time, depending on the earning increase, the prepayment options that come with a closed mortgage will generally be sufficient.
There are several pros and cons to both open and closed mortgages. As such one of the benefits of having an open mortgage is that you can make more regular payments with either no penalty or a little one, you can make a large lump-sum payment towards your mortgage at any point with no penalty or a little and you can refinance your mortgage, which is cheaper and much more flexible. However, the interest rates in open mortgages are very high as compared closed mortgages.
The benefit of having a closed mortgage is that the interest rates are lower as compared to open mortgages. However, the downside of having a closed mortgage is that you cannot increase your regular monthly payment without refinancing, and you can incur large penalties if you pay a lump-sum amount and refinancing your mortgage can be difficult and expensive.
