What do maple syrup and mortgages have in common?
Absolutely nothing. But now you’re thinking about how great maple syrup is (and how Canadian you are), and I believe it’s best to talk about mortgages when you’re in a good mood. So let’s talk a bit about closed vs open mortgages.
Choices, choices, choices…
Mortgages have evolved over many years as living situations, the economy and people have changed. Just like each individual is unique, mortgages come in all different shapes and sizes. At first, all the options and information can seem overwhelming, but that is a good thing because it means you’re getting closer to finding the best mortgage for you. Feeling confident in your mortgage is important and I’m going to help you get there!
Closed vs. Open Mortgages
When you select your mortgage you are going to be asked to commit to your lender for the term of the mortgage. But that might not suit your unique circumstances or be your style. Let’s talk about closed vs open mortgages.
What really is an open mortgage?
First, let’s define what an open mortgage is. The following are 3 of the most common characteristics of an open mortgage:
- You can make unrestricted pre-payments towards the principal balance
- You can pay the balance in full with no early payment penalty
- The interest rate tends to be higher for an open mortgage vs an equivalent closed option
Is your closed mortgage really “closed”?
And now for comparison let’s take a look at the most common characteristics and features of a closed term mortgage.
- You can make restricted pre-payments to the principal balance throughout the term. Typically between 10% to 20% of the original mortgage amount per 12 month period
- You might be restricted from making pre-payments in excess of the defined amount in the contract and/or an interest penalty might be applied if you exceed the 10% to 20% limits
- If you “break” the mortgage (paying the full amount back to the lender before the end of the term) there is an interest penalty applied
- Interest rates for closed mortgages are lower than their open mortgage equivalents
One common misconception about closed mortgages worth noting
I often see borrowers surprised by the flexibility of a “closed” term mortgage permits. There is a misconception that “closed” means you cannot make any pre-payments to the principal. However, once you understand your prepayment privileges they can be very unrestrictive.
For example, if you have a 20% per year prepayment privilege, and have the means, you can pay off your mortgage within 5 years of a 25 or 30-year amortization mortgage.
Some people are really really serious about paying off their mortgage and want to make extra payments on top of the ones they’re already making. These types of extra payments on a mortgage are called prepayments. The main difference between open and closed mortgages is the amount of flexibility you have in making extra payments on the principal or in paying off the mortgage completely. You have greater flexibility in an open mortgage and you can pay it off at any time open mortgages have a higher interest rate than closed mortgages.
What’s better for you?
For most homeowners, the mortgage is part of a long term strategy and financial plan so a closed mortgage is more than adequate. Pay attention to the details of your mortgage contract. For most borrowers, a 10%-20% prepayment privilege gives you plenty of runways to accelerate the repayment of the mortgage within your household’s means.
Not to mention closed mortgages are where we find the most attractive interest rates and lender offerings.
But an open mortgage might be for you if:
- You have timing issues; example your existing mortgage matures and you are planning to sell your house within 12 months
- You are expecting a large windfall of cash (like an inheritance or bonus) in the short term
- If you are borrowing money via a second or private mortgage
- You need the flexibility to refinance to tap into the equity in your home within a certain time period
These are generalizations and in the case of deciding between an open versus closed mortgage, it’s best to prepare a list of questions (after reading this blog) and bring them to a mortgage broker you trust.
Empowering mortgage newbies to feel confident and calm during and after the mortgage process is what I do. My blog is built from client feedback and years of experience with simplifying the number-crunching world of mortgages. Stay tuned for wittier (and useful) content by dropping your email below or getting in touch with us here!