Closed vs. Open Mortgage: Understanding The Differences

Closed vs. Open Mortgage Understanding The Differences

When you look up a mortgage website or get in touch with a mortgage lender, you may have heard the terms, ‘open,’ and ‘closed’ thrown around. If you’re new to mortgage processes, you may have difficulty understanding these terms.

Therefore, in this article, we’ll discuss what an open and closed mortgage is, what the differences are between the two, and which one you should go for when you’re looking for a mortgage.

So let’s begin!

Open vs. Closed Mortgage

Let’s discuss open vs. closed mortgage.

Open Mortgage

An open mortgage usually has a variable interest rate and is more flexible than a closed mortgage. Open mortgages also charge a higher interest rate than closed mortgages. You will probably have to pay the prime rate as well as a substantial premium.

However, you may go for a regular fixed-rate open mortgage if you believe you won’t be able to cope with variable interest rates. This is where the flexibility comes into play: you may pay the mortgage off, or move to a different product whenever you want.

The open mortgage terms vary between anywhere from six months to a year for fixed rates and three to five years for the variable ones. Moreover, you may pay the mortgage before maturity without any penalty. Furthermore, there are some mortgages that offer you to convert to a closed mortgage if you need to without a penalty.

Closed Mortgage

A closed mortgage usually has lower interest rates as compared to open mortgages; however, there is little flexibility for borrowers. If you pay off the mortgage before the maturity, you incur a penalty. You may get accelerated payments in some closed mortgages; however, every lender has their own terms of payments. Some lenders may even schedule the mortgage payments or get payments as an annual lump sum.

With a closed mortgage, borrowers need to agree to keep the mortgage for its entire term.

What About The Penalties?

Whenever a borrower breaks their mortgage (refinances in the middle of their term to have a lower interest rate), they are charged with a penalty. The amount of penalty can be anywhere from the interest of three months to an Interest Rate Differential (IRD). The IRD is a complex calculation, which may vary from lender to lender, but calculates the differential between the amounts you would have paid if you had continued with your payments versus what the lender may resell the money for in the market.

It is better that you know the difference between closed and open mortgages when getting a mortgage, as well as how various terms and conditions influence your bottom line.

The Difference Between Open and Closed Mortgage

The major difference between open and closed mortgages is the flexibility or restrictions you have on when you may pay the principal debt.

In an open mortgage, you may pay additional payments anytime without a penalty. These payments go to the principal debt, and as you keep reducing the debt, the less interest you would have to pay. Because borrowers have the choice of paying before maturity, this type of mortgage comes with a higher rate, compensating the fact that you can pay the mortgage payments early without penalty.

Closed mortgages are not this flexible. There may be closed mortgages that allow repayments, however, with some restrictions. All the other payments will incur penalties, which tend to add up quickly. Since closed mortgages do not have the freedom for early payments, they come with lower rates that are either variable or fixed.

Open Or Closed Mortgage? Which One Should You Choose?

Now here comes the question most people interested in mortgage want to be answered: what is the best one to go for, open or closed mortgage?

Should you go for a long and closed mortgage with low-interest rates, or opt for an open one with higher interest rates? Let’s be honest; the answer to these questions is entirely subjective; that is, it depends on your particular condition.

When looking for which mortgage to go for considering these circumstances:

  • Your current and future predictions of mortgage rates
  • Your preferred payment options
  • The level of flexibility you need
  • The potential penalties of payout
  • Your job security
  • The potential of rewards

Let’s elaborate further.

When you’re looking for a mortgage product, you need one that approximately fits or suits your current as well as future financial situations. Suppose you need a mortgage for a couple of years. In this scenario, there is no need for flexibility of payments in an open mortgage. Moreover, it is easier to predict your financial situation in the upcoming 1-2 years. However, when you need a mortgage for a longer-term, let’s say ten years, then it is quite impossible to predict your financial situation in the upcoming decade. Therefore, you want the flexibility in repayments.

When you opt for a closed mortgage, you get low-interest rates with scheduled monthly payments. There may be private lenders who may have limited pre-payment options without charging any penalty. If you think this may be beneficial for you, you may look for such lenders. In case there isn’t much flexibility available, you may sell the property to getaway out of the mortgage without getting a penalty.

You may think that with the high-interest rates, an open mortgage may not be the right choice to go for. However, as compared to the benefits and flexibilities it provides, it may be better for you than a closed mortgage.

Therefore, ask yourself these questions to know which mortgage may be better for you:

  • Are you planning or expecting to sell your house before the maturity of the mortgage?
  • Did you buy the house as an investment and want to flip it or sell it soon?
  • Are you expecting a considerable amount of money, such as inheritance, within some period of time?
  • Are you getting a small mortgage because of tax?

If you have answered yes to any of the above-mentioned questions, you may look at open mortgage options. An open mortgage offers you the flexibility you need to pay off the debt quickly without any penalties.

For everyone else, you may consider a closed mortgage. This is because the closed mortgage will give you the best rates without considering any other factors.

A Final Word

In this article, we discussed closed vs. open mortgage options, the differences between the two, and which one you should go for.

An open mortgage has flexible repayment options and has more interest rates. On the other hand, closed mortgages have stringent terms and have fewer interest rates. With a closed mortgage, you may incur penalties when you pay your payments before they’re scheduled. You may receive accelerated payments in a closed mortgage, but that flexibility varies from lender to lender.

Then we went on and discussed which mortgage type you should use. This, however, is entirely subjective and depends on various factors, such as your current and future financial situation, the level of flexibility you require, the potential payments you may get, your preferred payment options, your job security, the potential of rewards you may get.

We hope this article provided the knowledge you were looking for and benefits you in the selection of mortgage!

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