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Open vs. Closed Mortgages: Which One is Right For You?

Not all real estate is the same — and neither are all mortgages.

Therefore, it is important to understand the nuances and differences between various types of mortgages.

As an example, let’s have a look at open mortgages and closed mortgages.

Indeed, many people ask: what is an open mortgage loan (sometimes called an open-end mortgage)?

Fundamentally, an open mortgage is a mortgage which allows repayment of the principal amount of the loan at any time, without penalty.

Open mortgages are beneficial to people who desire to repay as much of their mortgage as they can, as quickly as possible. They might be expecting an increase in salary in the near future, or be self-employed and have a variable income. As the open mortgage will allow the borrower to repay the loan without penalty, obviously, the more applied to principal repayments, the less interest the borrower will eventually pay over the life of the mortgage.

Interest rates on open mortgages may be slightly higher than on a fixed mortgage. For example a Home Equity Loan Line of Credit (“HELOC”) may be considered an open mortgage and the rates are based on prime plus 0.50%. Such rate equates to almost 3% vs. under 2% for a typical  fixed rate mortgage.

Others want to know: What is an open variable mortgage loan (sometimes called “VRM”)?

This is similar to an open mortgage, but the interest rate is typically lower than that of fixed-rate mortgages. However, the main drawback is the risk involved, as interest rates could increase or decrease unexpectedly.

Yet, another important question: When should an open mortgage be considered?

An open mortgage is advantageous for a borrower who qualifies for a higher loan principal amount than what may be needed at this time.

The process for application is similar to other loans — and the terms are determined by a borrower’s credit score and credit profile. In some cases, borrowers may have a higher chance of approval for an open mortgage if they have a lower default risk.

Final question: what is a closed mortgage (also known as a closed-end mortgage)?

By contrast with an open mortgage, a closed mortgage allows for early repayment but with certain conditions or provisions attached. Such a mortgage cannot usually be prepaid, renegotiated or refinanced without a penalty being paid to the lender.

A closed mortgage may have a fixed or variable interest rate, but it will have several restrictions and limitations attached for the borrower.

For example, the equity a borrower has invested in a home cannot be used as collateral to secure additional financing. This means that if a borrower is 5 years into a 10-year closed mortgage and has paid off half of their debt, they cannot take out a home equity loan without the original lender’s permission. Furthermore, a penalty will be payable for violation of any of the restrictions of the loan.

Closed mortgages also prohibit pledging collateral that has already been pledged to another party. On balance, closed mortgages can be said to be more attractive for lenders as the borrower may be less likely to want to redeem his mortgage early. On the other hand they are  often less attractive to certain borrowers.

Should the borrower default, or enter into bankruptcy proceedings, a closed mortgage assures the lender that there are no other lenders who can claim the property as collateral. In exchange, the lender offering the closed mortgage might grant the borrower lower interest rates.

Some closed mortgages allow for accelerated payments of some kind, but each lender sets its own prepayment terms.

This type of mortgage may work for homebuyers who are not planning to move in the near future, or for those who can accept a longer-term commitment in exchange for a lower interest rate.

How to choose the right mortgage for you

When it comes to choosing the right mortgage:

  • Work out how much you can afford to repay each month to the lender
  • Calculate the likely upfront costs, including the initial deposit for the property — and then set a savings goal
  • Consult a reputable mortgage broker and:
    • Discuss the duration of the mortgage loan required
    • Make sure you understand how interest rates are applied to the loan
    • Consider your mid- and long-term financial position
    • Take advice on the loan type most suitable for you

Contact Axiom Mortgage Solutions

At Axiom Mortgage Solutions, we’re here to help. So, why don’t you give us a call and make an appointment to discuss your mortgage needs? We’ll be happy to assist!

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