A mortgage is a contract between a lender and a borrower. There are two types of mortgages. The first is an open mortgage and the second is a closed mortgage. Open mortgages (also called open-ended mortgages) give the borrower the right to repay all or part of the amount owed at any time without incurring any additional interest or fees (P. Dale, H. Jones 2015, s. 75). This is a good solution for people who have extra money they can repay earlier, because paying off extra amounts annually for the first five years can save a lot of money in the long run. Many open mortgages have options for six months or a year and involve higher interest rates, but if you are going to pay off your mortgage quickly, it will still be a better option than closed mortgages (K. Vermond 2010). It is always possible to change an open mortgage to a closed mortgage, but not vice versa (M. Milevsky 2001, s. 3). The duration of an open mortgage is from six months to five years.
Advantages and disadvantages of an open mortgage
A closed mortgage has its advantages and disadvantages and the same is true for an open mortgage. It is not possible to choose which option is more favorable, because it is an individual matter that depends on the borrower's expectations and plans for the future. It's worth analyzing the features of an open mortgage to see if it's the right option.
Advantages of an open mortgage:
- Flexibility - The main advantage of an open mortgage is its flexibility. At any time, if the borrower wants to transfer savings to pay back the loan, he can do so. Because of this, open mortgages are a good option for people who are able to pay off their loans quickly or are forced to do so (for example, due to plans to sell real estate).
- No financial penalties - Unlike closed mortgages, in the event of early repayment of a loan or refinancing, the borrower does not have to worry about penalties.
Disadvantages of an open mortgage:
- Increase in rates - The disadvantage of an open mortgage is that if rates can increase when the loan period ends. The borrower is then forced to pay a higher mortgage.
- Higher interest rates - Due to the flexibility of an open mortgage, it is more expensive, which allows lenders to impose higher interest rates than in the case of a closed mortgage. The cost of the loan will usually be higher because of a higher interest rate.
Summing up the pros and cons, it can be said that an open mortgage is a good option for people with differentiated income as well as those who are counting on a sudden cash flow that will allow them to pay off their debts quickly. It is also a good option for people who are not sure of the near future. However, for people who do not care about paying off the loan quickly and flexibility, a closed mortgage may be a more beneficial option.
- Dale P., Jones H. (2015) Mortgage Smarts, Friesen Press, s. 75
- Kiff J. (2009), Canadian Residential Mortgage Markets: Boring But Effective "IMF Working Paper", WP/09/130, s. 5-6
- Kolbe P., Greer G., Rudner H. (2003) Real Estate Finance, Dearborn Financial Publishing, Inc., s.126
- Milevsky M. (2001) Mortgage Financing: Floating Your Way to Prosperity, IFID Centre Research Report, s. 3
- Vermond K. (2010) Earn, Spend, Save: The savvy guide to richer, smarter, debt-free life, John Wiley & Sons Canada, Ltd.
Author: Agnieszka Damian