Is an Open Mortgage Right For You?
People are always looking for convenient things in life, and that often applies to financial products like mortgages. Homebuyers often have a variety of mortgage products available to them when they purchase a new home, and an open mortgage is one of those options.
What is an open mortgage?
Sometimes referred to as an open-end mortgage, an open mortgage is a mortgage product that allows you to prepay any amount of your mortgage principal – even the entire amount, if you can afford it – at your convenience without having to pay a penalty. This structure contrasts with closed mortgages, where there is an established prepayment limit in place. This means you are only allowed to pay a certain amount of the principal – usually 15% – annually. If you exceed that limit, you will incur a prepayment penalty from your lender.
Advantages of open-end mortgages
When you have a balance remaining on your mortgage principal, your goal is to get it paid off as soon as you can. Open mortgages are very flexible and allow you the convenience of making lump-sum prepayments whenever you want, whereas closed-ended mortgages are far stricter with their prepayment rules.
With an open mortgage, you can make prepayments of more than 20% of the amount of your original mortgage principal, which makes this mortgage a good choice for someone planning to sell their home soon. Some lenders may offer some form of prepayment option for closed mortgages, but that depends on their leniency towards mortgage prepayments.
Disadvantages of open-end mortgages
While the flexibility of making payments is certainly a plus, there are some disadvantages to open-end mortgages. The primary disadvantage of open mortgages is that the interest rates are always much higher than those of closed mortgages. In some cases, the interest rates are equal to the Bank of Canada’s prime rate – 5.34% as of this writing – plus a premium.
Because open mortgages allow you to pay more towards your principal, you may be able to offset the higher interest rate by reducing the amount of your principal. However, these higher rates often make open mortgages more prohibitive to some people. If the higher interest rate poses a problem for you due to a fixed or limited budget, it may be better to pursue a closed mortgage product with a lower interest rate instead.
Is an open mortgage right for me?
The mortgage product you choose for your home ultimately depends upon your current financial status. If you’re expecting a large sum of money or the sale of your property during the mortgage term, you might be better off with an open product. However, even in those instances, you might want to consider a one-year or similar closed mortgage. While open-ended mortgages offer more convenience in terms of prepayment options, these mortgage products require a larger financial undertaking due to higher interest rates over a five-year term.
To offer some perspective, as of June 2019, the rate for a five-year fixed-rate closed mortgage offered by the Bank of Montreal is 3.49%. BMO’s rate for a one-year fixed-rate open mortgage is 7.25%, which is more than double the rate for a closed mortgage. As a result, the cost of borrowing would be much higher in the long run for an open mortgage than a closed mortgage.
Because of the higher costs involved with closed mortgages, in some cases, it may be better to pay a prepayment penalty to your lender rather than deal with a higher interest rate. If your financial situation is not as good, it may be best to pursue a closed mortgage product instead. While it may take you longer to pay the principal off, the interest rates are much lower.
Before you make your selection, you should consult with your mortgage broker or lender first to determine which mortgage product would be the best option for you.