Open Vs Closed Mortgages: What’s The Difference?

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If you’re looking to get a new mortgage or you need to renew your current one, you’ll want to quickly become familiar with open vs closed mortgages. The most significant difference between open and closed mortgages is your ability to pay them off during the term.

Having the option to pay down your mortgage quicker is beneficial since you’ll pay less interest in the long run. However, having that option comes at a cost since the lender will potentially make less profit from you.

Making a decision between open vs closed mortgages is easy as long as you understand the differences.

What is a closed mortgage?

Closed mortgages have limited prepayment privileges. Generally, you won’t be able to fully pay off your mortgage, renegotiate, or refinance your mortgage before the end of the term without having to pay a hefty mortgage penalty charge. 

Generally speaking, most mortgage payments do have some prepayment terms in the contract. For example, you might be able to make up to an additional payment of 20% per payment. You may also be allowed to pay up to 20% of your initial mortgage balance once a year. These options will allow you to make additional payments, but you still won’t be able to pay off the full balance at any time without having to pay a fee.

What makes closed mortgages appealing in Canada is that you’ll get a lower interest rate compared to open mortgages. Since the lender knows you’re committed to the term, they’ll offer you a lower rate. Even if you do decide to pay off your mortgage early, the lender will happily take the fee that’s built into your contract.

Some people might be okay with paying the fee to pay off their mortgage early, but it can be expensive. The formula often used to determine your fee is based on the interest rate differential (IRD), or 3-months interest, whichever is higher. Depending on the size of your mortgage, you could end up spending thousands of dollars to get out of your contract. 

What is an open mortgage?

With open mortgages, the principal amount can be fully paid off at any time without a prepayment charge. You can also refinance or renegotiate your open mortgage before the maturity date, without having to worry about any fees. It doesn’t matter if you decide to pay off your balance a month after you get your mortgage, or a year later, there are no prepayment restrictions whatsoever.

The catch is that you won’t get the lowest interest rates with open mortgages. That’s because the lender has no idea when you’ll pay back your mortgage. They still want to profit from the loan, so they’ll charge you a higher interest rate. 

As you can imagine, open mortgages only make sense in a few specific situations. For example, let’s say you’re expecting to get a big work bonus or you’ll be getting an inheritance in the near future. You’re not sure when you’ll have the funds in your bank account, but you know it’s coming soon. In these scenarios, it would make sense to get an open mortgage as you can drop a lump sum into your mortgage at any time.

Keep in mind that an open mortgage contract still has a term. Unless you’re able to pay off the full balance from your financial windfall, you’d be on the hook for the higher interest rates for the rest of the term. 

Differences between an open and closed mortgage

The decision between choosing an open or closed mortgage is sometimes made easier when you look at the key differences.

  • Prepayments – Open mortgages allow you to make a lump-sum payment with no restrictions, whereas closed mortgages have limited options.
  • Prepayment penalty – There is no prepayment penalty with open mortgages. Closed mortgages will charge you the IRD penalty or three months of interest.
  • Interest rate – Closed mortgages have lower mortgage rates compared to open mortgages.
  • Term length – You can get a longer term of up to 10 years with closed mortgages. Open mortgages are typically capped at five-year terms.
  • Refinancing options – Refinancing and renegotiating can be done at any time for open mortgages with no fees. You can refinance with closed mortgages, but you’ll have fewer options and a penalty will need to be paid.

Note that with both open and closed mortgages, you can still get a fixed-rate mortgage or variable mortgage.

Open or closed mortgage, which is right for you?

When looking at open vs closed mortgages, all you need to do is look at your personal situation to come up with a decision. A closed mortgage will be the best option for people who don’t anticipate paying off their mortgage before the end of their term. To be clear, closed mortgages are the most popular type of mortgage for Canadian borrowers.

Open mortgages will obviously appeal to homeowners that want maximum flexibility. Having a higher interest rate may not matter to you if you know you’re going to pay off your mortgage in a few months or within the next few years. The additional interest you pay with an open mortgage could actually be less than what you’d pay in penalties for breaking a closed mortgage.

Keep in mind that it’s not just your current financial standing or expected financial windfall that should affect your choice between an open or closed mortgage. If your mortgage is up for renewal, and you suspect you may need to sell your home during the next mortgage term, it could be worth getting an open mortgage. For example, let’s say you’re thinking about moving countries in the next few years and you’ll need to sell your home to fund that move. 

Always consider the following when deciding between open vs closed mortgages:

  • How important is your monthly payment?
  • Do you want to be able to pay off your entire mortgage balance early?
  • Are you expecting a financial windfall?
  • Is there a possibility that you’ll need to sell your home before the end date?

If you still can’t decide between an open or closed mortgage, you may want to speak to a mortgage broker. Not only will they be able to go over the differences and how it applies to your specific situation, but they can also give you quotes on current interest rates. When you have the monthly payments in front of you, it can make the decision easier when choosing between open vs closed mortgages.

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About Barry Choi

Barry Choi is a Toronto-based personal finance and travel expert who frequently makes media appearances. His blog Money We Have is one of Canada’s most trusted sources when it comes to money and travel. You can find him on Twitter:@barrychoi

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