What is the difference between open and closed mortgages?
- Definition of Open or Closed
The main difference between open and closed mortgages is the ability and restrictions on when you can pay down the principal debt. In an open mortgage, additional payments can be made at any time without penalty. Those additional payments go directly towards the principal debt and the more you reduce this debt, the less interest you pay overall. Closed mortgages carry restrictions when it comes to making additional repayments. Some closed mortgages allow repayments, but only within certain restrictions. Any other payments will incur penalties that can add up quickly.
Why is this term important?
When additional payments go directly towards the principal amount, this means that the mortgage will be paid off faster as these extra payments are not split between the principal amount and the interest. Because an open mortgage offers flexibility with paying off your mortgage more quickly, this type of mortgage often comes with a variable mortgage rate, which is considered a higher premium for the freedom to pay down the mortgage without penalty.
Closed mortgages do not have as much freedom when it comes to repayment options, but can come with lower mortgage rates and either with fixed or variable rates. Repayment penalties are enforced with closed mortgages should your additional payment not fall within the mortgage contract guidelines. That means that while you cannot make additional payments during the time you hold your closed mortgage, most lenders will offer prepayment privileges. Prepayment privileges allow you to make extra payments during certain times of the year, or up to a certain amount. Closed mortgage repayment restrictions differ from lender to lender.
If you have an open mortgage or can make additional payments using prepayment privileges with your closed mortgage, consider using your work bonus or tax return for this opportunity.
Examples of term
For instance, a $100,000 closed mortgage may allow the borrower a chance to repay as much as $10,000 extra per year through a one-time additional prepayment. With an open mortgage, the borrower would be free to pay as much as they choose for an additional sum, at any time during the loan term, as a way of paying off the original loan principal faster.
There are many more options for fixed term closed mortgages, as lenders would prefer this type of loan over the open mortgage. That's because lenders can bank on the interest payments you make over the term of a fixed rate loan and this guarantee of money is how lenders earn a profit.