When it comes to mortgages, Albertans have a lot of choices. From banks and brokers to fixed or variable rates, new homeowners are able to custom tailor their mortgages to best suit their individual needs. Did you also know you can choose an open or closed mortgage?
In addition to choosing where to apply for a mortgage and at what rate, you can also have a say in how quickly you can pay it off. Below is a summary of how open and closed mortgages work to help you decide which option might be best for you.
It helps to think of an open mortgage like an open door policy for mortgage payments; you have the flexibility to pay off your loan at any time. So, you could purchase a brand new home and sell it within a year without any penalty from the bank. This also means you can fully pay it off, refinance or renegotiate at any time.
This added flexibility does come at a cost, however. Since open mortgage rates are usually variable, they are generally higher. This means what you gain in flexibility may cost you more in the long run. This can also put you at the mercy of the market as, when interest rates rise, so will your costs. However, open mortgages are so flexible you have the option to move into a fixed rate, closed mortgage at any time.
In short, open mortgages are best suited for homeowners who plan to pay off their mortgage before the end of term or are anticipating a large influx of cash from a divorce settlement, inheritance etc.
Conversely, closed mortgages are more restrictive than their open counterparts. With a closed mortgage, you’re agreeing to keep the loan for the entire term; ranging anywhere from six months to ten years. This means you can’t refinance, renegotiate or fully pay off your loan without penalty. So, if you decide to sell your home, you’re likely to face a break fee or mortgage penalty. This fee is the greater of either three months of interest on your mortgage or the interest rate differential (IRD).
The appeal of a closed mortgage ultimately comes from lower interest rates, saving you money over the course of the loan. These types or mortgages also lend themselves to fixed interest rates, which protect you from market volatility.
There’s also a small amount of flexibility that can accompany a closed mortgage. Depending on the lender, you may be able to increase your monthly mortgage payments and pre-pay an annual amount to be put towards your loan. For example, you can have a $250,000 mortgage with an $1,800 a month payment. Depending on conditions, you may be allowed a 100% increase on the monthly payment and a 25% annual pre-payment. This means, without penalty, you can make monthly payments of up to $3,600 and $62,500 as an annual lump sum payment. You will be penalized if you pay it off before the end of the term, though.
Which Is Best For You?
Having a clear understanding of your future plans will always help you make the best decisions when it comes to your mortgage goals. For example, if you plan on selling sooner rather than later, and/or want the freedom to pay off your mortgage sooner, an open mortgage may be right for you. On the other hand, if you’ve purchased a new family home where you plan to remain for some time, the stability offered by a closed mortgage may be ideal. Be sure to speak with your builder’s preferred lender for further information on which option is best for your unique needs.
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