Your guide to choosing the right mortgage for you
What is an open mortgage?
An open mortgage means that you can pay the whole mortgage balance off in full or in part at any point. Contracts for open mortgages can also be renegotiated or refinanced without penalties. These are a few of the reasons why open mortgages are so appealing to so many people. You can convert it to another term without a prepayment charge or you can simply pay it off earlier than expected.
Open mortgage terms are also typically shorter than closed mortgages, starting from six months and running up to five years. In Canada, open mortgages are less common. They are, however, a viable option if you are looking to pay off your mortgage early or if you want to deviate from the standard, longer-term repayment schedule.
However, the flexibility in terms of interest rates is high for open mortgages versus closed mortgage rates. You will most likely wind up paying the prime rate for an open mortgage as well as a substantial premium.
What is a closed mortgage?
Compared to an open mortgage, a closed mortgage has limited flexibility for borrowers and has more restrictions generally. With closed mortgages, you are not able to refinance or renegotiate terms without being penalized, and you can not pay off the loan early. On the plus side, compared to open mortgages, closed mortgages usually have lower interest rates.
Occasionally, a closed mortgage does offer prepayment privileges, letting you boost your monthly payments by a fixed percentage. Closed mortgages also allow borrowers to pay an annual lump sum, up to a certain percentage of the mortgage balance. Prepayment terms are set by each lender.
Since people do not plan to pay off their mortgages in the shorter term, generally, closed mortgages are the more popular choice in Canada. Terms for closed mortgages can vary from anywhere between six months and up to 10 years.
Advantages and disadvantages of open and closed mortgages
There are advantages and disadvantages of open and closed mortgages. A close mortgage, for instance, penalizes you for paying off part or all of your mortgage early. Closed mortgages also come saddled with a significantly lower interest rate, compared to open mortgages. Pre-payment penalties, can also be quite significant. An open mortgage, on the other hand, is much more flexible in terms of increasing your mortgage repayments, which you can do either by increasing your regular payments or through a larger lump sum.
Of the two, closed mortgages are more common in Canada. The reason for this is closed mortgages offer interest rates that are lower and generally, Canadians do not require the added flexibility offered by open mortgages. When you are expecting to get additional funds to pay off your mortgage, open mortgages are more sought after. Instances might include a significant bump in your income, an inheritance, or the money you get from selling your home.
The pros of an open mortgage include: you can make more regular payments with either no penalty or a little one; you can make a large, lump-sum payment on your mortgage at any point, with no penalty or a little one; and refinancing your mortgage is cheaper and far more flexible. The major con to an open mortgage is that they carry with them high mortgage rates than with close mortgages.
The major pro to a closed mortgage is that they offer interest rates lower than those of open mortgages. The cons of a closed mortgage include the following: you can not increase your regular repayments without refinancing; you can incur large penalties if you make a lump-sum payment; and refinancing your mortgage can be difficult—and expensive.
Read more: The types of mortgage in Canada you can choose from
How to choose the right mortgage for you
When choosing between an open and a closed mortgage, it is important to consider a few things. While Canadians typically opt for a closed mortgage because the added flexibility is not usually worth it, an open mortgage will make more sense for the following reasons:
You are about to sell your home. You might consider an open mortgage if you want to pay off your mortgage with the proceeds of selling your house. If you pay off the whole closed mortgage, you will likely incur significant prepayment penalties.
You are about to receive an inheritance. If you are expecting an inheritance, you can put the money toward a lump-sum payment with little or no penalty.
You earn more income. In this instance, an open mortgage will let you increase your regular mortgage payments but without incurring a penalty.
