Open vs. Closed Mortgage: Differences Explained

Written By
G. Dautovic
Updated
July 22,2022

If you are planning to buy a house or a piece of property, a mortgage is a common financing solution. However, with a wrong mortgage plan, you might end up paying more than planned.

Mortgages are a big decision, and there’s a lot to consider before taking one out. These days, there are a lot of different types of mortgages available, so it’s important to understand the differences before you make your choice. In this article, we’ll look at some things you should keep in mind when selecting a loan. We’ll discuss the pros and cons of open vs. closed mortgages so that you can make an informed decision. 

So, whether you’re buying your first home or refinancing your current mortgage, we’re here to help you evade mistakes and choose the right plan for you.

What Is a Closed Mortgage?

Pros Cons
Lower mortgage rate Refinancing can be expensive
  Closed mortgage prepayment penalties

Closed mortgages offer predictability and stability, especially if you choose a fixed rate. That locked-in rate will remain in place for the entire life of the loan, giving you peace of mind when it comes to budgeting. Closed mortgages typically have lower interest rates than open mortgages, which can save borrowers thousands of dollars. 

Let’s say you want to take a mortgage to purchase a home. You sign the contract and start repaying the loan, but you inherit a large sum of money a couple of months later. Usually, you’d put that money in the mortgage payment, but there would likely be repayment penalties due to the closed loan contract you signed. However, most closed mortgages allow you to prepay a certain amount each year without penalty. This amount is typically up to 20% of the original loan amount.

Unless you’ve agreed to a variable closed mortgage, you cannot change the amount of your payment or the period you need to pay it without exposing yourself to the fee. The term for a closed mortgage loan can be anywhere between six months and 10 years.

Interest Rate Differential

When considering a closed-end mortgage, one important factor to keep in mind is the interest rate differential (IRD). It represents the distinction between the interest rate on your mortgage and the interest rate on comparable security. 

IRD is, in other words, the cost of breaking your mortgage contract early. If you need to break your mortgage contract before it matures, your lender will charge you the IRD as a closed mortgage prepayment penalty. It’s best to choose a closed-end mortgage with a low IRD in order to minimize your costs.

To find out the IRD on a particular closed-end mortgage, simply ask your lender or look it up online. When comparing different mortgages, be sure to compare IRDs in addition to interest rates to get the full picture.

What Is an Open Mortgage?

Pros

Cons

No limitations on the payment rate 

Higher interest rate

Refinancing is not as expensive

 

By definition, an open mortgage rate offers borrowers the flexibility to make additional payments without incurring any penalties. This can be especially beneficial if you get some extra money or simply want to pay off your mortgage faster. 

Making larger payments can help reduce your overall interest costs and may even allow you to shorten the term of your loan. Additionally, an open mortgage gives you the option to take a payment break if you experience financial difficulties. This can provide some much-needed breathing room without putting your home at risk. As such, an open mortgage offers several advantages that may appeal to borrowers in various situations.

You could end up paying more interest overall with an open mortgage because open rates are usually higher than closed rates. There’s not much of a debate about open vs. closed mortgages in Canada. Closed mortgages are more popular as people prefer paying a lower interest rate. 

Still, an open mortgage is a great choice for those whose monthly earnings are not uniform, such as freelancers or those expecting a pay raise in the future. Suppose you’re 25 years into a 30-year amortization and want to refinance your loan to take advantage of a lower interest rate. In that case, you should be able to do so without penalty, thanks to the open term.

An open mortgage term can be anywhere between six months and five years.

Fixed and Variable Mortgage Interest Rates

There are two main mortgage interest rates, fixed and variable. Both come with their  advantages and can be applied equally to closed and open mortgages. 

Fixed Mortgage Interest Rate

A fixed-rate mortgage rate allows absolutely no flexibility in paying off the mortgage. The payment terms are set in stone, and there are penalties for any deviation. The penalty is typically the interest rate differential or a three-month interest on your current mortgage principal, whichever is greater.

A 5-year fixed closed mortgage is the most common choice in Canada today.

Variable Mortgage Interest Rate

The difference between a fixed and a variable mortgage rate is interest rate fluctuation. A variable-rate mortgage wavers over time as it’s usually tied to one financial index, making it a more risky choice. 

While the mortgage rate stays the same, your interest rate fluctuates depending on the current market. If the interest rate drops, more of your payment will go into paying off the rest of the debt. However, if the interest rate rises, you’ll end up paying a higher rate.

What To Consider When Taking Out a Mortgage?

Whether you’re looking into an open or a closed mortgage, here’s what else you should consider before making a decision:

  • Income
  • Expenses
  • Risk tolerance

Once you determine these factors, take into consideration closed vs. open mortgage rates and choose whichever suits you better.

Conclusion

Paying out a mortgage is no small task. It can be a long and stressful process, one that is not to be taken lightly. Make sure you are on good terms with facts, terminology and different types of mortgages before making a final decision.

So, which mortgage is best for you? The answer to that question depends on your unique financial situation. If you’re not sure which option is right for you, or if you have any other questions about mortgages, don’t hesitate to reach out to a trusted mortgage broker for advice. They can help you choose the right solution and walk you through the entire process from start to finish. 

FAQ

What is the difference between an open and a closed mortgage?

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An open mortgage allows the borrower to make additional payments, pay off the entire loan early, or make changes to the terms of the loan. A closed mortgage, on the other hand, has strict rules about payments and early repayment. As a result, closed mortgages typically have lower interest rates than open mortgages, but they may also have higher penalties for early repayment or missed payments. When deciding which type of mortgage is right for you, it is important to consider your financial goals and risk tolerance.

What does an open mortgage mean?

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An open mortgage allows you to change the terms of your mortgage, make prepayments or lump-sum payments and pay off your full mortgage at any time. However, it comes with higher interest rates than a closed mortgage payment.

What are the advantages of having an open mortgage?

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An open mortgage allows you to make lump sum payments or prepayments on your mortgage without being penalized. This can be helpful if you come into some extra money or want to pay off your mortgage sooner. It can also help to reduce your overall interest costs. However, open mortgages typically have higher interest rates than other types of mortgages.

Is an open mortgage more expensive?

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​​Many people assume that an open mortgage is more expensive than a closed mortgage, but this is not always the case. An open mortgage allows you to make prepayments and break your mortgage contract without incurring penalties, while a closed mortgage typically charges a hefty fee for doing so. As a result, an open mortgage can actually be cheaper in the long run if you need or want to pay off your mortgage early.

Is a closed mortgage good?

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It depends on your unique financial situation. When it comes to open vs. closed mortgages, people tend to opt for a closed mortgage. This way, they can make stable plans for their finances and know exactly how much they need to set aside each month.

About author

I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.

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