Open vs Closed Mortgage: What’s the Difference?

Open vs Closed Mortgage: What’s the Difference?

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    Published 21/12/2020 12:12 EST

    There’s no such thing as a one-size-fits-all mortgage. At nesto, we look at all your needs – both short- and long-term – to decide which type of mortgage best suits your unique financial situation. And then we find you the very best interest rate! Below is a comparison between open and closed mortgages to help you understand the benefits and drawbacks of each option.

    Key Takeaways
    • With an open mortgage, you’re able to pre-pay any amount of your mortgage at any time without facing a pre-payment penalty, but your interest rate will be higher than with a closed mortgage
    • With a closed mortgage, the interest rate is more attractive than an open mortgage because you’re limited by how much extra you can pay towards your mortgage each year
    • When considering a variable or fixed rate, your decision should be based on your risk tolerance as well as your ability to withstand increases in mortgage payments

    What’s an open mortgage?

    With an open mortgage, you’re able to pre-pay any amount of your mortgage at any time without facing a pre-payment penalty. 

    The compromise for having an open mortgage is that interest rates are higher to make up for the flexibility of being able to pay it off at any time. 

    What’s a closed mortgage?

    With a closed mortgage, the interest rate is more attractive than an open motgage because you’re limited by how much extra you can pay towards your mortgage each year. 

    The compromise for having lower interest rates than an open mortgage is that you’ll face a pre-payment limit. This means that you’re only permitted to pay a certain percentage of your original or current balance per year – often 15%, on average, but this varies between lenders. And if you choose to pay more than your annual limit, you’ll receive a pre-payment penalty. It’s important, therefore, to be aware of your limits and stay within them. 

    Tip

    Whenever possible, be sure to select the ‘original mortgage balance pre-payment option’ as this will enable you to pay off more in a year than the ‘current balance’ alternative

    Open vs closed pros & cons

    The major pro of an open mortgage is that you have the flexibility to pay it off at any time. The biggest con is that, in order to have this flexibility to pay off the mortgage in full whenever you wish, you’re going to pay a higher interest rate than with a closed mortgage.

    The key pro for a closed mortgage is that you’ll have access to lower mortgage rates than if you choose an open mortgage. The largest con is that you’ll be charged a pre-payment penalty if you pay off more of your mortgage than the allotted annual amount stipulated by your lender in your mortgage contract. 

    Important

    The ‘term’ refers to the duration of your current rate, whereas your ‘amortization’ is the length of time it will take to completely pay off your mortgage

    Variable vs fixed rate

    Currently, nearly 70% of home buyers in Canada have a fixed mortgage rate. And, more than 60% chose 5 years as the renewal term for their mortgage. 

    Having a ‘fixed’ rate means that your rate will remain the same over the term of your mortgage. 

    Although the 5-year fixed-rate option is undoubtedly the most common choice selected by Canadian homeowners, this isn’t always the best choice for everyone. Your decision should be based on your risk tolerance as well as your ability to withstand increases in mortgage payments. This is where our expert support is even more invaluable.

    Sometimes it makes sense to opt for a lower or higher term than 5 years. Did you know that you could secure a fixed-rate mortgage at any increment ranging from 1 to 10 years? We can advise which option best suits your unique needs. 

    A variable-rate mortgage fluctuates with the lender’s prime rate throughout your mortgage term. So, while your variable-mortgage payment will remain the same throughout your term, your interest rate may change based on market conditions. If the prime rate rises or falls, this impacts the amount of principal you pay off each month. When rates on variable mortgages drop, more of your payment is applied to your principal balance. And, conversely, if rates increase, more of your payment will go towards the interest portion of your mortgage.

    The most popular variable-mortgage terms are 3 year and 5 year, although they’re available in all increments from 1 to 5 years, with some lenders offering longer terms as well. See: Should I Get a Fixed or Variable Mortgage Rate 

    When selecting a term length you have to weigh a few factors, including how long rates are going to stay low or high and the duration of time you plan to stay in your home. Breaking your mortgage early can lead to some hefty early payout penalties. See: Breaking Your Mortgage Can Cost Tens of Thousands of Dollars, But an Alternative Exists!

    Which rate should I choose?

    Selecting a mortgage rate and product that’s right for you involves a lot of background work based on your specific needs, financial state and credit situation, to name just a few factors. That’s why nesto has compiled a Mortgage Rate Guide to help you navigate the ins and outs of what goes into the mortgage selection process – and answer all your questions along the way.

    Ready to get started?

    In just a few clicks you can see our current rates. Then apply for your mortgage online in minutes!

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