Open vs. closed mortgages
When you are searching for the mortgage with different lenders or looking on the mortgage company websites you’ll see different terms and one of them is open mortgage payment vs closed one, choosing what’s best for you depends on your expected needs during the length of the mortgage term.
Open term mortgages are flexible in that you may be appealing if you are planning to pay off your mortgage in the near future and they can be repaid either in part or in full at any time without penalty in order to pay the loan before the end of the amortization period. It allows you the freedom to put prepayments toward the mortgage loan anytime until it is completely paid off however the interest rates for open mortgages are generally higher than for closed mortgages because of the added pre-payment flexibility.
Closed term mortgages are usually the better choice if you're not planning to pay off your mortgage in the short term. Interest rates for closed term mortgages are generally lower than for open term mortgages. Closed term mortgages offer you the ability to save on interest costs and payoff your mortgage faster. You will pay a prepayment charge if you wish to renegotiate your interest rate, prepay more than your mortgage allows or pay off your mortgage balance prior to the end of its term. Each lender sets its own prepayment terms. Some lenders will let you double up your scheduled mortgage payments or pay an annual flat rate.
What is the prepayment penalties?
Break fees are generally either the sum of three months of interest on your mortgage or the interest rate differential (IRD), whichever is greater.
The IRD is the difference between what you would have paid in interest and what the bank can now make on the funds they lent you, based on the current rates, for the remainder of your term.
If you were paying the bank 4% interest and they can now only lend the money out for 2.6 %, you have to pay back the difference. Of course, the more months left on your term, the greater the IRD penalty because the difference in interest is incurred for a longer period of time.
The IRD usually only applies to fixed rate mortgages. Unfortunately, today’s falling fixed interest rate environment means borrowers are almost guaranteed to pay the IRD, and that’s often a nasty surprise to Canadians who failed to read the fine print of their mortgage contract.
When you’re shopping for mortgages, use our powerful comparison tools to take a peek at rates for both open and closed mortgages.
Which one suits you better
The main difference between an open mortgage and a closed mortgage is the flexibility you have in making extra payments or paying off the mortgage in its entirety. Paying down your mortgage more quickly means less money going to the bank in interest.
You may want to consider an open mortgage if you hope to pay off the mortgage soon or if you have extra money to put toward the mortgage
A closed mortgage might be a good option if you plan to live in the home for the length of the mortgage term ,Don’t expect to have extra money to make additional payments Or, the limited prepayments offered by the mortgage are flexible enough
If you want a mortgage with a shorter term, say, one or two years, then you probably won’t have as much need for the flexibility of an open mortgage. On the other hand, if you know that you want a 10-year mortgage term and the stability of consistent payments for that period of time, you can’t expect to know how your financial picture will look in a decade. In that case, then you’ll want as much flexibility as you can get, which includes the option to make prepayments if you’re able to do so during that time.
Mortgages are a lot more complicated than they used to be and this post is just another illustration of why partnering with a knowledgeable mortgage expert is the best way to save money for the client.
Reference: which mortgage, mortgage websites