Spring is here, which means the housing market in Ottawa is going to pick up again soon. We get a lot of questions this time of year about open and closed mortgages, mostly wondering which is best for you.
This article will take a look at both open and closed mortgages, and help you determine which is the best option for your home and financial situation.
WHAT IS A CLOSED MORTGAGE?
Simply put, a closed mortgage is one that can’t be paid off fully, or refinanced until the end of term… at least, not without incurring a penalty. So if you get a raise at work, or end up receiving an inheritance you’re most likely better off investing that money elsewhere, until your mortgage needs renewal. If you find yourself in this situation then you need to do some math. For example, if you have an additional $20,000 you wanted to put down on your mortgage, you’ll want to find out how much that lump sum will save you on interest payments and then subtract the penalty the lender will charge. Then compare that amount to the interest you will make off investing it temporarily in a mutual fund until you’re able to refinance your mortgage.
There are some lenders that provide a bit of flexibility, allowing you to increase payments by a certain percentage, the amount and conditions vary from lender to lender.
On the bright side, a closed mortgage usually offers better rates than an open mortgage. This is beneficial if you want stability in your finances or prefer to budget for your monthly expenses. A closed mortgage also allows you to forget about it until it’s time for renewal again.
WHAT IS AN OPEN MORTGAGE?
If flexibility is important to you, then you may be more interested in an open mortgage. This is one that can be paid off in full when you like, or renegotiated at any time without penalties. Essentially, there are no restrictions on repayments. This is beneficial if you get a raise and want to add that money onto your monthly payments, or if you’re on the receiving end of a financial windfall.
All this flexibility comes with a cost though. Open mortgages tend to have higher monthly payments since the borrower doesn’t have to hold the mortgage until maturity.
CHOOSE A CLOSED MORTGAGE IF…
- You’re worried about making payments: If it’s important to keep your monthly payments low, a closed mortgagewill offer you better rates.
- You don’t want to think about it: If you want to set up automatic payments from your bank account and not think about your mortgage again until its next renewal.
CHOOSE AN OPEN MORTGAGE IF…
- You’re planning to sell your home soon(ish): Paying off a closed mortgage can set you up for some steep prepayment penalties.
- You have an inheritance coming: If you’re expecting a lump sum of cash anytime soon (that you’re planning to put towards your mortgage), then an open mortgage will allow you to do that without penalty.
- Your income is about to increase: If you’re getting a promotion, or your partner got a new job and you’d like to increase your monthly payments then an open mortgage will allow you to do that.
CLOSED MORTGAGES WITH A VARIABLE RATE
If you’re looking for a compromise, a closed mortgage with a variable rate may be your ideal solution. The rates are usually still a bit lower than open mortgages, but if you do end up putting a lump sum towards your mortgage, the prepayment penalties are usually lower. The flipside to this option is that your rates will be exposed to changes which could increase the amount of your regular monthly payments.