So what is an open mortgage you ask? Well you have come to the right place. Read on to find out exactly what an open mortgage is.
An open mortgage gives you the ability to to pay a portion or the entire amount of your existing mortgage at any time. When you do this you will not incur any sort of penalty, or prepayment charge. With an open mortgage, often the interest rate is higher versus when you have a closed mortgage. The greatest benefit of an open mortgage is by far its tremendous flexibility. An open mortgage gives you options until you are ready to switch into a closed term with a lower interest rate, if that is what you wish to do down the road. Now when we say it give you ‘options’, that is exactly what it gives you. For example, if you buy a house, you get into an open mortgage, and then you hav to sell your house shortly after you purchase it, you will not incur any penalty upon selling. Versus when you are in a closed mortgage, often you will have a penalty charged to you by the lender for ‘breaking’ that mortgage prior to its maturity.
So why would someone buy a house and need to sell it shortly after? There are many cases in which this could apply. One example is if someone gets relocated by their company. They might not have been planning it and the relocation may come suddenly. If that is the case, they would need to sell their home and potentially buy a new home in the new city or state that they are moving to. Having an open mortgage in a scenario like this is great because you can break your mortgage, with no penalty.
Now here is a detailed example of an open mortgage that you may find helpful. Follow along and read this case study twice if it does not make sense to you after the first read.
Here is an example of an Open Mortgage
Mr. Belding recently purchased a new home worth $500k and took an open mortgage in the amount of $300k. Mr. Belding is going to be selling some of his other assets in the near future, which consist of some income properties. He would like some flexibility to pay a large lump sum on his mortgage in the coming months. Mr. Belding ends up selling one of his investment properties for $300k and applies the entire amount of the proceeds of the sale to pay off his mortgage without penalty.
Mr. Belding made a good decision to go with an open mortgage. Compared to a closed mortgage, he would have been limited to a 10-20% prepayment privilage. Not only that, he would have incurred a pre-payment penalty. In Mr. Belding’s case, the higher interest rate on the open mortgage was worth paying over the penalty.
Here are the advantages of an Open Mortgage
An open mortgage can be a very good fit for people with income that varies, such as the self-employed. If a self-employed person has a month where they get an extra $7,000, they can put that amount down on their open mortgage without incurring any penalty.
An open mortgage is also a good solution for someone getting a large sum of money in the future, similar to Mr. Belding’s case. The borrower can make a lump sum payment directly towards the principal amount owing. We sometimes see this example with first time buyers with Baby Boomer parents who have money to spare. The Baby Boomer parents might provide their offspring a large amount of money, either as a down payment at the time of the purchase of a new home, or later down the road the money is provided. Whenever the money is provided from the parents, it is put down towards their offspring’s mortgage balance. With an open mortgage, this is easily done and no penalty is incurred. With a closed mortgage, this is more complicated to do, and penalties can be incurred.
What are the disadvantages of an Open Mortgage?
The main disadvantage of an open mortgage is a big one. You guessed it! It is the interest rate. It is generally at least 1% higher than a fixed term, closed mortgage. 1% may not seem like a lot to some, but this number is a big deal for many. With an increased interest rate on an open mortgage, some people feel very reluctant in taking an open mortgage versus a closed mortgage. The extra 1% people feel is too much, and in particular they feel that their monthly mortgage payments will be too high. Therefore, they opt to not go with an open mortgage and they chose a closed mortgage instead.
If a homeowner has a fixed budget and is trying to ensure that their mortgage payments stay as low as possible, a closed mortgage is the correct option for them. With a lower rate, a fixed mortgage may make better economic sense, and will provide security to the homeowner as they will know that their payments are lower and manageable.
an open mortgage – things to remember
Remember that an open mortgage is a mortgage that allows repayment of the principal amount at any time, without penalty.
In an open mortgage repayment terms are more flexible than a closed mortgage, which do not usually allow for prepayment without penalty.
The Open Mortgage – a final definition
An open mortgage gives the borrower the ability to be able to repay all or part of the mortgage at
any time during the term without paying a prepayment charge. The interest rate on an open
mortgage is often higher than the interest rate on a closed mortgage. An open mortgage
provides flexibility until you are ready to lock into a closed term.
The flexibility offered can be a very helpful tool for the home owners. If you are planning on paying your mortgage down faster than the average person, an open mortgage makes sense.