The difference between an Open and Closed Mortgage
When you’re signing up for a mortgage, there are many terms to understand: fixed vs. variable, term vs. amortization period and open vs. closed mortgage. Most people are familiar with the first couple terms, while fewer people are familiar with the last term, open vs. closed mortgage.
Many Canadians shop solely for the mortgage with the lowest rate. While I think just about everyone wants a competitive mortgage rate, there are other things to consider. One of those is whether your mortgage is open or closed.
An open mortgage is a mortgage where you can pay it off in full at any time without incurring a penalty. That sounds pretty good, right? You may be wondering why everyone doesn’t sign up for an open mortgage.
The reason is that open mortgages almost always come with higher mortgage rates than the other type of mortgage we’re going to talk about today, closed mortgages.
For that reason, open mortgages only make sense under certain circumstances.
An open mortgage can make sense if you expect to receive a cash windfall and plan to pay off your mortgage soon. Closed mortgages have limited prepayment privileges where you’ll incur penalties for exceeding them, not so with open mortgages. You can pay off an open mortgage without penalty whenever it suits you.
An open mortgage can also make sense when you plan to sell your home soon. For example, if your mortgage is coming up for renewal, but you haven’t quite found the home you want to buy, but you definitely plan to move, you might choose to go with an open mortgage to avoid paying the penalty later on.
The second type of mortgage in Canada and by far the most popular is closed mortgages. When you think of a mortgage, a closed mortgage is most likely what comes to mind first. When lenders advertise mortgages, the term “closed” is often omitted because it’s the type most Canadians are looking for. You’ll usually only find the term “closed” in the fine print of the mortgage contract.
There are limitations to how much and how quickly you can pay off your mortgage with a closed mortgage. If you exceed those prepayment privileges, you could incur costly mortgage penalties.
The reason for that is that mortgages are resold to investors. Those investors are banking on certain rates of return. Mortgage penalties compensate investors for lost interest to make them whole again.
That’s not to say that you can’t put any extra money towards closed mortgages. It’s quite the opposite. A lot of lenders are pretty generous with how much you can put towards closed mortgages.
Commonly, you can make lump sum payments of 20 percent per year and increase your mortgage payments by 20 percent per year. If you did that, you could have your mortgage paid off before the end of your five-year mortgage term.
Just be careful of the mortgage penalties with closed mortgages because they can be costly, especially with fixed-rate mortgages that are closed.
The Bottom Line
Are you not sure whether an open or closed mortgage is right for you? Please speak with our mortgage experts today. Our experts would be happy to help you figure out the right type of mortgage for you.