Open vs Closed Mortgage: Which One is Right For You?

By Rachel Burke

There's a lot of confusion out there over which is the best mortgage for your situation, and which one will fit your budget better. Or maybe you're wondering if you would even qualify for one at all. When looking at the big picture, it is important to note that there are two types of mortgages: closed mortgages and open mortgages. There are pros and cons to both types, but the closed mortgage is the more traditional version of the two.

An open mortgage has flexible repayment options. This means that regular payments can be increased or lump sum payments can even be made. Because of their flexibility, interest rates are usually higher. A closed mortgage does not allow you to pay any more than the decided monthly amount. If you pay off your mortgage early, you will be penalized. When deciding between a closed and an open mortgage, factors such as interest rates, the flexibility of repayment terms, penalties for early payoff, and your future plans should be scrutinized.

In Canada, closed mortgages are more common because they have lower interest rates. Further, most people do not require the extra flexibility that comes with an open mortgage. People usually select open mortgages if they expect to receive a large lump sum in the near future so that they can pay off their mortgage earlier. The large lump sum might come from an inheritance, proceeds from a home sale, or an income increase.

Pros and Cons: Open vs Closed Mortgages

Your main question may be which type of mortgage you should apply for, but before you make that decision, it's important to understand the pros and cons of each: 

How to Pick the Right Mortgage for You

For the average Canadian, a closed mortgage offers the best value. Most people signing a mortgage do not require the option of changing monthly payments or making lump-sum payments. Closed mortgages also come with more attractive interest rates, which can save money over the term if you don’t expect to have any extra money to put towards the mortgage. 

For those who expect additional money to come soon and want the freedom to pay off the mortgage, then an open mortgage might be appropriate. The following are situations where an open mortgage might be the preferred option:

• You're selling your home soon: An open mortgage might be suitable if you have the intention of selling a property in the future and plan on applying those proceeds to pay out your current mortgage on another property. Paying off a closed mortgage early will lead to penalties.

• You expect to receive a large inheritance or severance payout in the near future: If a cash inheritance or severance payout are on their way, you can use these as lump-sum payments on an open mortgage without penalty.

• You expect a pay increase: If you expect a promotion or job change with higher pay to happen shortly, an open mortgage will allow you to increase your monthly mortgage payments without penalty.

What Are Open Mortgage Prepayment Charges?

Prepayment charges are a common term used to describe a mortgage loan protection feature whereby a portion of the mortgage is paid off prior to maturity that protects the lender from being unable to collect all of the "loan balance" when it comes due. The concept is that the borrower can prepay the portion of the loan that is not covered by mortgage insurance, which protects the lender from loss of principal in the event of a borrower default.

Fixed vs Variable Mortgage Rates

Most Canadians prefer a basic closed mortgage with a fixed interest rate for its simplicity. The mortgage terms are easier to understand and there are no surprises. 

“Fixed rate” means that the rate will remain constant over the duration of the term. While the 5-year fixed-rate mortgage option is the most popular, it’s not necessarily the best choice for you. The decision should be made based on your risk tolerance. For some, it will make more sense to secure a shorter or longer term. It’s important to speak with your financial advisor to find out which option is the best for you.

On the other hand, an open or closed mortgage with a variable interest rate allows a homeowner to benefit from an interest rate that is adjusted based on changes in the market. The variable rate may rise or fall, depending on where the prime level stands and how much it fluctuates. This option allows you to capitalize on lower rates when they’re available, and gives you more flexibility over the term of your mortgage.

Open vs Closed Mortgage: Which Bank Do I Choose?

While many factors go into making a good mortgage choice, digging into the financial details can be a bit overwhelming. It is easy to be intimidated by pages of numbers and terms that don't mean anything to you, and you may have no idea where to start. 

Choosing a bank you can trust to help you with your real estate transaction is one of the most important decisions you will make. When you first begin your search, you may be overwhelmed by all of the options out there. So, how do you choose the right one? Here are a few questions to ponder to help you make your decision:

• Do they offer fair rates? 
• What conditions and fees will they impose on your home loan? 
• Do they have flexible products that can meet your needs? 
• How long have they been in business? 
• What kind of security will you receive for your home loan? 
• How does customer service stack up?

Once you consider these questions, you'll be well on your way to finding a lender that meets your needs who will be able to help you determine which type of mortgage is best given your situation.