The fact that you’re researching mortgages probably means that you’re about to make an investment. If you’re planning to buy a home or any real estate property, there’s a big chance that you won’t pay for it in cash. You’ll need to secure a mortgage for the home you have your eyes on.
Once approved, you could repay the loan based on agreed-upon terms, which include interest rates, payment amount, time and amortization, among others.
Depending on your situation and financial capability you can choose between an open mortgage or a closed mortgage. How do these differ from one another? Also, how can you determine which option is best for you?
Open mortgages boast flexibility.
The entire mortgage balance can be paid off, re-negotiated or refinanced at any time without penalties. Open mortgages may allow you to put extra money towards your mortgage aside from your regular payment. You can pay off your mortgage in full before the term payment ends or choose to re-negotiate before it ends. With open mortgages, you could break your contract to change lenders before the term ends.
Let’s say you’re foreseeing an influx of income, perhaps an inheritance in the near future or a lump-sum bonus coming in. You’ll have the flexibility to put this towards your mortgage. This could save you thousands of dollars from decreasing interest charges. A sudden shift in your family’s circumstances or a change of plans can also pave the way for more cash on hand, like selling the property and having to move. If this is the case, then an open mortgage may suit your circumstances.
For borrowers who fear penalties, this could be very enticing. But take note, an open mortgage has a term and tends to have higher interest rates as compared to a closed mortgage because of prepayment (extra payments above your normal monthly payment) flexibility. Open mortgages are usually available short-term that are less than five years.
Closed mortgages are accessible.
On the contrary, a closed mortgage can’t be fully paid off, refinanced or renegotiated before the term ends, unless the borrower is willing to pay the penalties and applicable charges. This is usually a better choice if you’re not planning to pay off your mortgage. When you opt for a closed mortgage, you commit to being bound by its terms and conditions for the duration of the term.
Having fixed monthly mortgage payments could also be beneficial for the buyer, especially when it comes to budgeting family expenses such as tuition fees, groceries, utilities and so on.
If you feel constrained or locked into the terms and conditions, some lenders allow you to make prepayments up to a specified amount, on an annual basis. This allows you to pay a certain percentage of the originally agreed-upon mortgage, without penalty. For instance, if you had a closed five-year fixed mortgage with 20% annual payment privileges, you couldn’t pay more than 20% of the original mortgage amount before maturity. If you did, this would mean a penalty fee and these fees can be hefty.
Open or closed mortgage
There’s a lot to consider when paying off mortgages. The main contrasts between the two are their flexibility and interest rates. Deciding which mortgage to choose depends on your financial situation as well as your foresight on what your financial situation will be in the future.
For instance, if you’re leaning towards a shorter term, let’s say two years, then you may not need the amount of flexibility that an open mortgage offers. Apart from unforeseen circumstances such as unexpected emergencies or unforeseen disasters, you’d have an idea of what your finances would look like in the next few years.
On the other hand, if you’re choosing a 10-year term, you’d need the type of flexibility that an open mortgage offers in case you earn more money – or less. Even the best planners will find it hard to foresee their finances that far into the future.
Simply put, closed mortgages generally offer better interest rates than open mortgages, but it limits the borrower’s flexibility. Choose wisely to avoid landing a bad mortgage.
So what should you choose?
There’s no right nor wrong answer here. The rule of thumb for loans and investments is to choose what’s best for your financial situation while being on top of your finances.
To sum up their differences and put them into practice, look into these scenarios:
- Choose an open mortgage if you are planning to make changes to your living arrangements in the near future or if you intend to make large payments that’d be more than the allowable prepayment under a closed mortgage;
- Choose a closed mortgage if you’re planning to stay in your current home and not planning to sell.
Explore more options for your mortgage needs
The most important take-away is to study and analyze your financial situation and trends in order to enhance your foresight.
Besides, you have a long list of terms and conditions to choose from. You can almost tailor-fit them to match your needs. Gain financial insights with the help of Daisy Raouph, your trusted mortgage broker and financial adviser.