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For most of us, buying a property is a significant financial decision. A critical aspect of this process is choosing the right mortgage to finance the property. There are two main types of mortgages – open or closed. This article outlines the pros and cons of each type of mortgage and explores how each one could benefit you based on your financial goals.
What Is A Mortgage?
A mortgage is a loan provided by a lender or bank to help you purchase a property or house. The property serves as collateral, and the borrower repays the loan, with interest, over a predetermined period. The two most common types of mortgages are open and closed mortgages. Each type of mortgage offers pros and cons. The next section outlines everything you need to know about open mortgages:
What Is An Open Mortgage?
An open mortgage is a type of home loan that allows the borrower to make additional payments toward the principal amount at any time without incurring penalties such as prepayment charges. This flexibility means you can pay off your mortgage sooner if you have extra funds.
The Pros Of An Open Mortgage:
- Flexibility: An open mortgage means you don’t need to commit to paying off your home mortgage at an agreed-upon time – you can pay it off sooner if your finances improve over time.
- Available for long and short-term periods: You can choose how long you’d like to commit to an open mortgage based on whatever works best for you.
- No prepayment penalties: A prepayment penalty is a penalty charged for paying off a loan earlier than expected. Since an open mortgage allows for early payment, these charges do not apply.
Saves costs over time: If you pay off your home earlier, you avoid the long-term financial costs of paying off a house over a longer period.
The Cons Of An Open Mortgage:
- Higher interest rates: Because of its flexibility, open mortgages have higher interest rates than closed mortgages. In Canada, the average yearly fixed interest rate for an open mortgage is 9.75%.
- Might pay more: If you don’t pay off your mortgage earlier you may end up paying much more for your property than if you chose a closed mortgage.
Open mortgages allow you more financial flexibility, but their high interest rates can be a deterrent if you have a tight budget. With this in mind, a closed mortgage may offer a better option. The next section covers the basics of closed mortgages.
What is a Closed Mortgage?
A closed mortgage has fixed payment terms. You’re committed to a set schedule, and any attempts to pay off the loan before the end of the term can result in prepayment penalties. While this option offers less flexibility, it does come with lower interest rates and its own set of pros and cons.
The Pros Of A Closed Mortgage:
- Lower interest rate: The typical fixed interest rate of a closed mortgage in Canada is 7.89% for a year-long contract. This can be a more manageable payment if your budget is smaller.
- Limited prepayment options: While open mortgages don’t come with prepayment penalties, closed mortgages often include a permissible yearly amount you can pay penalty-free.
Stability: Closed mortgages are perfect for those who value stability and predictability in their budget. Knowing how much you need to pay monthly and for how long can help you plan for a long-term future with much more specificity.
The Cons Of A Closed Mortgage:
- Prepayment penalties: Unfortunately, you have limited options for paying off your loan earlier if you go with a closed mortgage, and attempting to pay it off early comes with expensive penalties.
- Cannot refinance or sell your home: While you are still paying off your closed mortgage, you cannot refinance or sell your home unless you are willing to pay additional penalties or fees.
While a closed mortgage may seem daunting due to its lack of flexibility, it is also the most popular choice of mortgage due to its lower interest rates and predictable payment schedule. Now that you know the pros and cons of each type of mortgage, how do you choose between the two? The next section offers a few factors to consider.
Factors To Consider When Choosing Between An Open Or Closed Mortgage
It can be tough to choose the right mortgage for you, below are a few things to consider during the process:
- Financial future: If you expect a significant increase in income, a promotion, or an inheritance, an open mortgage might be a good fit.
- Predictability: If you prefer a fixed repayment schedule with a pre-determined due date, a closed mortgage is most likely the best choice.
- Interest rates: Open and Closed mortgage interest rates differ by roughly 2%, but that 2% can make a massive difference in the payments you make. Consider which option is most viable for you.
- Potential penalties: If you plan to sell your home or refinance in the near future, an open mortgage would provide more flexibility.
If you’re still unsure which option to choose, consider seeking professional advice. A mortgage broker or financial advisor can both offer valuable financial insights and help determine the best choice for you. While it can be costly to pay for a consultation, an informed decision can save you money in the long term.
Conclusion: Making The Right Mortgage Decision For Your Financial Future
Choosing between an open or closed mortgage requires thorough research and consideration of your financial situation. An open mortgage offers financial flexibility and may suit buyers whose finances are set to improve over time, while a closed mortgage offers stability and peace of mind for home buyers who don’t mind paying steadily until the agreed-upon due date.
Whatever you end up choosing, remember – at the end of the day owning your own property is a step towards securing your financial future.
