Closed vs Open Mortgage

How to Decide Between the Two

Choosing the right mortgage could be just as important to your success as choosing a house. Mortgages come in two varieties, open-ended and closed-ended mortgages with different advantages and disadvantages.

Choosing between open and closed mortgages is a challenging task for everyone, but understanding the advantages and disadvantages of each mortgage will help you choose the right option for your finances. Take into consideration how long you plan to make monthly payments, how much money you have for a down payment, and what kind of interest rate would fit best with your budget.

What is a closed mortgage?

A closed mortgage is usually the more popular option because it carries a lower interest rate. The term, payment frequency, and monthly payment amounts are set. Many closed mortgages allow limited prepayment privileges that often allow some flexibility in repayment, such as doubling monthly payments or making a lump sum payment on the anniversary of the mortgage date.

These prepayment privileges will vary from lender to lender so it is important to find out what kind of prepayment privileges you are getting before deciding on a closed mortgage. Closed mortgages come with restrictions. If homeowners attempt to remortgage, renew or renegotiate the terms of their mortgage agreement, or fully repay the balance before the end of the mortgage term they will face costly penalties.

When you purchase a closed mortgage, you are committing to the terms for the duration of your loan.

What is an open mortgage?

An open mortgage is the opposite of a closed mortgage in that it gives you the flexibility to pay off your mortgage completely before the end of the term, make lump sum payments, renegotiate terms or refinance the mortgage without incurring penalties.

In contrast to a closed mortgage, there are no restrictions on when you can pay your monthly installments or how much you must pay in addition to your regular installments. Open mortgages allow you to increase your monthly payments when your income increases, making it easier to pay off the principal balance and save money on interest.

If you come into a lump sum of money through investments or inheritance, you can use the funds to pay your mortgage in full without penalty and save thousands on the interest.

Advantages Of A Closed Mortgage

If you come into a lump sum of money through investments or inheritance, you can use the funds to pay your mortgage in full without penalty and save thousands on the interest.

Disadvantages Of A Closed Mortgage

Although closed mortgages reduce the potential for hefty interest rates, they are not without their own set of drawbacks. Although closed mortgages allow for lower interest rates, they also come with their own set of drawbacks.

You cannot increase your regular payments without refinancing or a penalty fee will incur. Lump-sum payments can result in a significant penalty cost so saving on interest by paying down the principal balance is not always worth it. When you refinance your mortgage and want to break the loan early, you will incur expensive penalties.

Lastly, if you plan to move in less than 5 years, closed mortgages are not a suitable choice.

Advantages Of An Open Mortgage

One of the most notable advantages of an open mortgage is that you can make lump-sum payments or take out a refinance without having to pay any penalties. Neither deal has penalties associated with it and allows flexibility in terms of payment amounts.

The terms for open mortgage loans are much shorter than traditional mortgages as shorts as 5 years. The short terms on open mortgages allow you the opportunity to renew or refinance for better interest rates without incurring significant penalties. If you plan on moving in 5 years, this is a great option.

Disadvantages Of An Open Mortgage

Open mortgages have far more benefits than drawbacks. To ensure you choose the best mortgage that meets your needs, consider the few of the disadvantages, too.

Open mortgages often offer higher interest rates, and so the cost of borrowing will be much more expensive than with a closed mortgage.

Open or Closed Mortgage? Choosing The Right Loan For You

The option of an open mortgage is useful to some homeowners, but a closed mortgage will provide most homeowners with the best overall value. Open mortgages typically have higher interest rates than closed mortgages because of the high prepayment flexibility. As a result, open mortgages are far less popular as compared to closed, which are available for longer terms.

Closed mortgages are best for those who do not anticipate any drastic changes to their situation throughout the course of the loan and would like to take advantage of the lower rates. Open mortgages have shorter terms, usually 5 years or less. They are best for people who plan to relocate in the upcoming years and those who plan to pay off their mortgage as quickly as possible.

The Bottom Line

Choosing between open and closed mortgages can be difficult. You should choose the type of mortgage appropriate to your long-term plans, as choosing the wrong kind could land you in expensive penalties or you might be spending a lot more on interest in the future.

Open and closed mortgages have their own advantages and disadvantages, and choosing the right one could save you money and help you meet your financial goals. Regardless of the mortgage you choose, it is important to shop around for the best rates.

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