Choosing between a closed mortgage and an open mortgage is a key decision in the process of purchasing real estate. There isn’t a one-size-fits-all answer, but that’s okay because you can figure out which option makes the most sense for you by understanding what a closed mortgage is, what the benefits of a closed mortgage are, what the disadvantages are, and the overall differences between open and closed mortgages.
It’s normal to have to shop around for a mortgage. You can approach banks or a mortgage broker to secure the funding you need to purchase a property, but before you start to shop around, you need to understand the differences between open vs closed mortgages.
What does a closed mortgage mean?
A closed mortgage means that there are penalties if you want to pay them off early. With a mortgage, you have the total amount that you’re borrowing, which can take decades to pay off. From there, it’s divided into a smaller mortgage term, which presents the opportunity to refinance your mortgage, re-negotiate, or to make other changes like switching to another lender.
With a closed mortgage, you can’t make extra payments to shorten your mortgage, you can’t fully pay down your mortgage early. When the term is up, you’ll have more freedom to make changes, but during the term, you’re locked-in. If you come across a lump sum of money, and you have a closed mortgage instead of an open mortgage, you won’t be able to
What is a closed variable mortgage?
A variable closed mortgage means that when interest rates change, your monthly payment will stay the same. The amount of money from each payment that goes towards the interest or the principal will change, however, even though the sum of the payment stays identical from month to month. Lower or higher interest rates won’t change your monthly payment, but you’re still impacted by changes in interest rates. When rates a lower, a larger chunk of each payment goes towards the principal. When internet rates are higher, a greater amount of each payment will go towards interest, meaning it will take longer to pay down your mortgage.
What about a closed fixed interest rate mortgage?
A closed fixed-rate mortgage means that your interest rate is locked in for the length of the term. Unlike a variable, the interest rate stays consistent. You’ll usually end up paying a somewhat higher rate, but you are immune from market fluctuations. Some people prefer to pay a slight premium price in order to know their interest rate will remain the same throughout the term of their mortgage.
Advantages of a closed mortgage
Every type of mortgage has its own benefits and drawbacks and closed mortgages are no exception. Whether a particular type of mortgage is a good choice or a bad choice really comes down to who is borrowing the money and what their plans are.
The best-use scenario for a closed mortgage is when you’re planning to live in the property for a long time, you don’t plan to come across a lump sum of money to make a large payment, you won’t be selling the property anytime soon, you don’t want to make any additional payments beyond what’s allowed in the terms of your mortgage, and you don’t have any intentions of trying to refinance your mortgage. In other words, if you’re okay with your mortgage staying exactly the same throughout the term, then a closed mortgage can be a really good choice.
Why are there so many rules with closed mortgages, what do you gain from all of that? You will get better mortgage rates on a closed mortgage, most of the time, and that’s why people choose them when they meet the aforementioned criteria.
Mortgages come in many shapes and sizes, and there are some great benefits of closed mortgages, but there are also some downsides to them, too.
Disadvantages of a closed mortgage
There are some downsides to a closed mortgage, too. This is why it’s important to understand the differences and reflect on whether a closed mortgage really suits your needs, or if you’re better off keeping your mortgage open. We’re going to cover open vs closed mortgage information in a moment, but going over the disadvantages of closed mortgages first will help set the scene.
The main disadvantage of a closed mortgage is that you cannot pay it down early without facing penalties. If you have an inheritance on the way, rather than having a bunch of cash sitting around, you could pay off your mortgage (in whole or a chunk of it) if you’re not in a closed mortgage that prevents that.
What is the difference between an open and a closed mortgage?
To summarize everything, an open mortgage offers you the opportunity to renegotiate, refinance, or completely pay it off at any point without having additional penalties. In a sense, since an open mortgage can be a bit costlier, you are paying a form of penalty. It’s not an official penalty in the same sense that you face with a closed mortgage, but paying a slightly higher price throughout the term of the mortgage could be seen as a type of penalty that you pay for the privilege of having an open mortgage.
With a closed mortgage, you’re locked in. You’ll pay slightly less unless you decide to make any changes to the mortgage as discussed above. If you do want to repay early, you’ll pay a penalty, and this time it’s a blatant penalty. You may be allowed to make some extra payments as per the terms of your agreement, but you won’t be able to pay it all at once, and you’re usually very limited on extra payments with a closed mortgage. That’s not the case with an open mortgage, you have more freedom.
Can you break a closed mortgage?
It’s possible to break a closed mortgage if your lender allows you to. There are penalties for this, but if you agree to sign a new mortgage with the same lender, it’s possible that they’ll agree to cut you some slack and to reduce that penalty a bit because you’ll still have your business, instead of you breaking the mortgage to go with a different lender.