Getting a mortgage is likely one of the most important financial decisions you will ever make. Getting the right mortgage for you and your situation takes planning and some research, but it’s well worth the effort because choosing the best option can save you thousands of dollars while your mortgage is active. We’re going to look at the difference between open and closed mortgages, and a couple of their more popular variations.
There are open mortgages, closed mortgages, variable rate mortgages, and fixed rate mortgages. They each serve a great purpose, so let’s start by understanding open vs. closed mortgages. We’ll define and explain them all in this mortgage guide.
Open vs Closed Mortgages
Open Mortgage Definition
An open mortgage is a mortgage where the entire loan can be paid off early, payments can be increased by large amounts, and the mortgage contract between you and the lender can be refinanced and negotiated with absolutely zero penalty.
Open mortgages usually have higher interest rates and shorter mortgage terms, five years or less. This is the tradeoff for the high level of flexibility that an open mortgage offers.
You might want to choose an open mortgage if you plan to pay off your entire mortgage quickly, selling your home in just a few years for example, and want to avoid the potentially high prepayment fees which are typically associated with a closed mortgage. That said, an open mortgage is less common in Canada than closed mortgages.
Closed Mortgage Definition
A closed mortgage is a mortgage where a only small amount can be paid off early, regular payments can be increased only slightly, prepayment fees can be significant, and the contract is largely unchanging during the mortgage term.
Closed mortgages are the more popular option in Canada because, while they are less flexible than open mortgages, they are much more stable if you plan on paying off your mortgage over the long term. These mortgages are also very attractive because the interest rates are usually much lower than the rates offered with open mortgages.
You might want a closed mortgage if you plan to stick to the regular mortgage payments, pay off your mortgage over a longer period of time, and choose a new interest rate at the end of each term. This is the option for you if you want to have a more “hands off” approach to your mortgage.
Pros & Cons of Open Mortgages
Allows you the freedom to pay it off early or increase your monthly or bi-weekly payments as much as you want
No prepayment fees
Refinancing and negotiating your loan contract are much easier than a closed mortgage
High interest rates
Short mortgage terms
Pros & Cons of Closed Mortgages
Lower interest rates
Longer mortgage term lengths
Stable and uncomplicated
You can’t pay the entire mortgage off at once and you usually can’t increase your monthly or biweekly payments above a certain amount.
High prepayment fees
The loan contract is largely unchangeable during the mortgage term
Closed Fixed and Closed Variable Mortgage
Closed mortgages are the most popular option in Canada. They provide a simple and manageable payment schedule with low interest rates. These mortgages assume that people will pay the loan down over the long-term.
There are two variations of closed mortgages that we want to explore here, and they deal with the interest rate you will be offered during each mortgage term until the loan is paid in full.
Many mortgages are only paid off after 20 to 30 years, but mortgage lenders split these years into terms, shorter time periods that are usually two to 10 years long. At the beginning of each mortgage term, including when you first get your mortgage, you will be offered an interest rate by your lender. That rate determines how much interest you will pay on your mortgage with each monthly or biweekly payment you make.
These interest rates can either be fixed or variable.
A fixed mortgage rate means that once you and your lender agree to a mortgage rate at the beginning of the term, it will not change. It won’t go up or down no matter what happens. This can be good, or it can be bad.
If you lock into a low mortgage rate right before interest rates jump up a few percentage points, then you’re laughing. Your interest rate will not change until your term ends. Then you can renegotiate with your lender based on the interest rates available at the time.
A variable mortgage rate means that your interest rate can go up or down depending on what the Prime Rate does. The prime interest rate of Canada, or Prime, is an interest rate which most of the major banks and financial institutions agree on, and they use it to determine variable rates for lots of types of loans, including variable-rate mortgages. Prime is determined by many economic factors, and it goes up and down many times throughout the year, but usually not drastically.
So, if you get a variable rate for your mortgage and the next day Prime plummets, then your mortgage rate will also drop. Your interest rate is entirely based on the prime interest rate, plus a little extra which is added on by your bank. But, the opposite could also happen, then you’re left with a high interest rate which you can only hope will go down the next time Prime is adjusted.
Open vs Closed Mortgages: Which is best for me?
Open vs. closed mortgages, you don’t want to choose the wrong one and feel like you’ve messed up a major financial decision. Selecting the right one requires you to put in the legwork, ask questions, read up about what’s best given your financial situation.
So, what option is best for you? Look ahead a few years and ask yourself, “Do I expect to pay off my mortgage through selling my house or receiving a bunch of money in the next 10 years?”
If you anticipate inheriting a large sum of cash or you value the flexibility to potentially pay off your mortgage despite the higher interest rates, then choose an open mortgage.
If you answered “no” to the question above, then choose a closed mortgage which offers much lower interest rates and a stable payment structure with manageable monthly or biweekly payments.
Talk to a financial adviser or mortgage broker to figure out what’s best for you. They will be happy to help you understand what type of mortgage suits your situation.