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Open vs. Closed Mortgage: What’s the Difference?

Everyone dreams about buying a house someday. The biggest challenge that one has to face while buying a house is finding a mortgage or applying for a mortgage. With so much information already available, it becomes quite confusing what to do and what not to do. Well, worry not because we are here for you. This article will help you learn things that you need to know about mortgages like, What is an open mortgage or a closed mortgage. 

When you choose the right type of mortgage, it is going to save you money and you can utilise it for investment or instalments. So without any further wait, let’s get started.

What is an Open Mortgage? 

An open mortgage is a flexible mortgage term that provides you with the option to repay the amount or the interest at any time in regular payment or through a lump sum amount. For example, if you have bought a house with a mortgage of 10 years and if you think that you have the money and you want to pay it back now rather than waiting for the term to be over, this is the option that will benefit you the most. 

When you know that you are going to get money anytime soon, your salary is going to increase or you are going to get something in your inheritance then you can opt for an open mortgage because that will set you debt free sooner than a closed mortgage.

Read: Canada Mortgage And Housing Corporation (CMHC): What is It?

What is a Closed Mortgage? 

Totally different from an open mortgage in a close mortgage, if you choose to pay the amount you owe to the lender at an early date, it is going to cost you a lot in terms of interest rate and principal amount payback. If you are going to make constant monthly payments without any advance payment, this option will save you because generally, the interest rate is quite lower for a closed mortgage. 

A lot of people in Canada do not have that amount of financing available that they can pay their mortgage loan at an early stage. And thus, a closed mortgage comes to their aid. 

What are the Advantages and Disadvantages of Open vs Closed Mortgage? 

For a better understanding have a look at the table below and get an idea of what kind of mortgage will suit you.

Pros and Cons of an Open Mortgage

ProsCons
Flexibility to pay the amount as per their convenience.Higher rate of interest due to given flexibility.
No penalties or fines if choose the option for prepayments.The cost of borrowing is high compared to closed mortgages.
Can choose for refinancing at lower rates.

Pros and Cons of Closed Mortgage

ProsCons
Lower rate of interest.Long terms of payment ranging between 6 months to 10 years.
The cost of borrowing is less.No flexibility for refinancing.
Prepayment of loan attracts penalties or fees.

How to Choose the Right Type of Mortgages?

Typically for Canadians, a closed mortgage works better because it provides a lower interest rate. Most people do not want the flexibility to pay the mortgage amount before the tenure. You can choose that if you are running low on cash or want to have a stable payment option for a longer term with lower payments. 

In case of the following situations you can opt for an open mortgage because in these cases, it will save you money compared to a closed mortgage.

Read: Canadian Real Estate Market: The Income Required For A Home In Canada’s 10 Largest Cities

1. You are Planning to Sell Your House Soon 

If you are thinking that in the future you will sell your house and that will pay back your mortgage amount then you should opt for an open mortgage. In this case, if you choose a closed mortgage the pre-payment would be too much higher in terms of penalties and interest rate and will cost you a lot. 

2. You are Expecting an Inheritance

If you are aware that you are going to get a cash inheritance anytime soon then you should choose an open mortgage because in that way you can pay the mortgage amount in a lump sum and can reduce the overall mortgage sum on which the interest is calculated. It would eventually reduce your monthly payments as well. 

3. You are Expecting a Raise in Your Income 

If you know that a promotion or a salary hike is on the way then you should go for an open mortgage because it will allow you with the flexibility to change the monthly instalment and you can pay a large amount and reduce interest payment, too. It will save you from the penalties that you would have to pay if you choose a close mortgage. 

In short, in an open mortgage, you are paying a little higher interest rate compared to a closed mortgage because you are getting more flexibility.

Read: A Simplified Guide On How To Buy A Home In Canada

Do Closed Mortgages Provide a Flexibility?

Yes, if you are applying for a closed mortgage, and if you opt for variable rates then you can have lower penalties when you make a prepayment. It would still be higher compared to an open mortgage but compared to fixed it close mortgage it would be much lesser. 

It will provide you with a mixture of lower mortgage payment and you can pay the amount in advance and the penalty would be minimum. 

One of the biggest challenges with this term is that you will also be exposed to any kind of changes in the Prime mortgage rate. If the mortgage rate increases it would also increase your instalment amount. So, research well and choose the best option that you think would provide you with the benefits.

Also, keep in mind the following details before making any decisions. 

  • How much payment can you make each month for your mortgage?
  • Will you be able to pay the mortgage in advance or in prepayment?
  • What are your monthly expenses? 
  • If you are planning to sell your house anytime soon.

Are You a First Time Home Buyer?

If you are a first time home buyer, here are a few tips for you. 

  1. Plan for your dream house in advance to avoid consequences later.
  2. Choose for a neighbourhood considering the long term implications of your life like nearby schools for your kids, hospitals, etc. 
  3. Search for homebuyer programs offered by the Canadian government to help you save money. 
  4. Save for a down payment.
  5. Apply for pre-qualification and preapproval of mortgage loan.
  6. Save for closing costs.
  7. Stick to your budget keeping in mind the mortgage instalments you would need to pay and your income inflow. 
  8. Look for a reliable broker for closing the deal.
  9. Do your own homework and research well.

Jason Cohen

Jason is a writer and personal finance expert at YourFirst.ca. He is a finance enthusiast and loves to talk about Canadian Finances, Real Estate and Financial Freedom. He is an advocate for financial literacy and is helping to make a difference by educating Canadians on personal finance via his platform at YourFirst.ca

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