What is an open mortgage?
- Definition of Open Mortgage
An open mortgage is a loan which allows the borrower to make any sum of additional payments, at any time, that go directly onto the principal amount, without penalty. An open mortgage means the loan is not restricted to terms and conditions that prevent the borrower from attempting to pay off the loan as quickly as possible—the borrower is open to pay back the loan whenever they are capable of doing so.
Why is this term important?
When most borrowers make a mortgage payment, a large percentage of this monthly payment goes towards the interest on the account, not the principal. This means borrowers end up paying interest on the interest that has accumulated. To reduce the overall cost of a mortgage, borrowers need to reduce the overall mortgage principal, which is why having the ability to pay money towards the principal amount is so valuable.
With an open mortgage, when you receive an inheritance, get a significant tax return, or accept a substantial bonus through work, you would be able to put as much of this money towards that outstanding mortgage loan. These additional payments go directly towards the principal debt owed and you end up paying less interest on the mortgage in the long term.
Without an open mortgage, borrowers either cannot make additional payments without penalty or must adhere to the contract prepayment guidelines. Prepayment penalties, when made on a closed mortgage, can cost the borrower thousands of dollars.
Due to a large amount of flexibility given with an open mortgage, you will pay more and deal with more variable rates. However, an additional benefit to holding an open mortgage is that you can switch to another product at any time, such as fixed rate rather than variable, without penalty.
Examples of term
When making additional payments to your open mortgage, you can quickly speed up the process of paying your mortgage off. Say your inheritance was $100,000 and you put that full amount on your $300,000 mortgage. With this payment, your mortgage will now be at $200,000 without penalty and every payment you make after this means more of the monthly sum is going to pay off that principal debt.