What is open vs closed term?

Answered by Jason Smith

Open vs Closed Term Mortgages: Explained

When it comes to mortgages, there are two main types of terms that borrowers need to consider: open and closed. Understanding the differences between these terms is crucial in making an informed decision about which type of mortgage is right for you.

An open mortgage is a type of loan that provides flexibility in terms of prepayment options. With an open mortgage, you have the ability to make additional payments or pay off the entire mortgage balance at any time without incurring penalties. This can be particularly beneficial if you have extra funds available or if you anticipate a significant increase in income in the near future.

On the other hand, a closed mortgage is a more restrictive option. With a closed mortgage, you are limited in terms of prepayment options. Typically, you can only make prepayments up to a certain percentage of the original mortgage amount or within specific time frames. If you want to pay off the mortgage in full before the end of the term, you may face penalties or fees.

One of the main advantages of a closed mortgage is that it usually offers a lower interest rate compared to an open mortgage. Lenders are willing to provide a lower rate because they have more certainty about the length of the loan term and the interest income they will receive. This can result in significant savings over the life of the mortgage.

However, it’s important to consider your individual financial situation and future plans before deciding between an open or closed mortgage. If you anticipate needing flexibility in terms of prepayment options, such as receiving a bonus at work or selling a property, an open mortgage may be the better choice for you. This allows you to take advantage of opportunities to pay down your mortgage faster or even pay it off completely without penalties.

On the other hand, if you have a stable income and don’t foresee any major changes in your financial situation, a closed mortgage may be a more suitable option. The lower interest rate can save you money in the long run, and the limited prepayment options may not be a concern if you don’t plan on making significant additional payments.

It’s also worth noting that some lenders offer a blend of open and closed terms, allowing borrowers to have a portion of their mortgage as open and the remainder as closed. This hybrid option provides a balance between flexibility and the potential for lower interest rates.

In my personal experience, I initially opted for an open mortgage when I purchased my first home. At the time, I had some extra savings that I wanted to use to pay down my mortgage faster. However, I soon realized that I didn’t have as much disposable income as I had anticipated, and I wasn’t able to take full advantage of the prepayment options. In retrospect, a closed mortgage with a lower interest rate would have been a better fit for my financial situation.

The choice between an open and closed mortgage term depends on your individual circumstances and financial goals. An open mortgage provides flexibility for prepayments but may come with a higher interest rate. A closed mortgage offers a lower interest rate but limits your ability to make additional payments without penalties. Consider your financial stability, future plans, and the potential for extra income when deciding which type of mortgage term is right for you.