There are many loan products in the market, making it confusing and stressful for homebuyers to choose one. There are fixed-rate, variable-rate, lines of credit, and so much more! In this comprehensive guide, we break down what open and closed mortgages are, to make your home loan search a bit easier.
An open mortgage has flexibility. You could make lump sum payments or accelerate your payments without penalties, giving you the ability to pay off your home loan before the end of the amortization period.
For example, imagine you purchased a home for $400,000 and took out a $250,000 open mortgage. You have a start-up business that is about to boom in the near future, which would help you with your mortgage repayment later on. Because you have an open mortgage, you could put a large amount towards your loan without penalty once more profit comes in from your start-up.
If you are considering an open mortgage, some of the things you should look into are:
- Extra repayments. If you are expecting a huge amount of money and want to pay off your mortgage earlier, an open mortgage could be ideal. You could pay whatever amount you want towards your loan and make the amortization period a bit shorter.
- Loan terms. This mortgage type’s term could range from six months to a year if you opt for a fixed rate, while three to five years for variable rates.
- Penalties. With an open mortgage, you do not have to worry about penalties should you want to pay off your loan or refinance.
- Good for the long run. If you plan to take on a two-year loan term, an open mortgage may not be ideal as you may not need the flexibility it offers. However, if you know a 10-year mortgage term is what you want and would like the flexibility in the future; this may be a good option.
- Higher interest rate. With this type of home loan, the interest rate may be higher than a closed mortgage, which may result in paying more for the loan.
A closed mortgage is pretty much the opposite of an open one. It has restrictions when it comes to extra repayments. Some lenders may not allow you to pay off your mortgage before the term ends without incurring a large penalty.
For example, imagine you purchased a house for $400,000 and took out a $250,000 closed mortgage with a 4% interest rate for five years, with a 30-year amortization period. Your monthly repayment would be $1,193.54. According to your mortgage contract, any prepayment above a 15% lump sum annually will incur a penalty. If you opt to make a prepayment towards the 15% lump sum, a penalty would apply.
Similarly, if you want to refinance your mortgage before the five-year term ends, you would pay for a penalty.
Want to check how much your possible mortgage repayment could be? Our handy calculator can help you.
If you are considering a closed mortgage, some of the things you should look into are:
- Extra repayments. While making extra repayments or prepayments may be possible with this type of loan, you may have to incur a penalty. As mentioned, some closed mortgages may have a prepayment limit, which means you may have to pay for penalties if any repayment over the limit is made.
- Lower interest rate. Compared to an open mortgage, you may enjoy a lower interest rate with this type of loan. This mean, you may enjoy lower repayments for your loan.
- Restrictions. A closed mortgage is not as flexible as its open counterpart. You may not be able to break your loan term without paying a hefty fine.
- Longer terms. For this loan type, the terms are longer, varying from six months to 10 years.
Which one is for you?
After weighing in the pros and cons of these types of mortgages, you still have a few things to consider before making your final decision. Some of these may be:
- Your financial situation. Your finances will greatly affect the type of mortgage you chose. Evaluate your income and how much you could shell out for repayments. You don’t want to end up with a mortgage you can’t afford.
If you want a more stable repayment scheme and do not mind having restrictions, a closed mortgage may be for you. On the other hand, if you are expecting an improved financial situation and would like to pay off your mortgage a lot sooner, an open mortgage may be your best bet.
- Your expenses. You also have to consider how much you spend monthly to better understand how mortgage repayments would fit in. Ask yourself: are there expenses I could cut back? Would my lifestyle suffer because of a mortgage? Can I shell out extra money for my repayments?
These are just some of the questions that could help you with your decision. If you want lower repayments, a closed mortgage with a lower interest rate may be for you. However, if you could shell out a bit more extra for your prepayments but don’t want to incur any penalty, an open mortgage could work.
- Future plans. If you have plans of moving or refinancing your home loan before its end date, you might want to consider an open mortgage. With a closed mortgage, refinancing would incur a hefty penalty, while with an open mortgage you may not have to worry about a fine.
Alternatively, if you do not plan on refinancing or you see yourself permanently settling into your house, a closed mortgage could be ideal.
If you are still unsure about the type of mortgage you should get, consider getting help from a professional such as a mortgage broker. He or she will consider your financial situation and your other needs when recommending loan products to you. A broker also has access to a range of lenders and may even give you financial guidance that could make your decision a bit easier.
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