What to choose…a closed or an open mortgage? Let’s have a look at both and their highest and best uses to help you decide.
A closed mortgage refers to a mortgage agreement that cannot be prepaid, renegotiated or refinanced before maturity, except according to its terms. Some flexibility to repay the principal through lump sum payments or an increase to the monthly payment is allowed. Closed mortgages can be a good choice if you want a fixed payment schedule, and you don’t plan on moving or refinancing before the end of the term. Breaking a closed mortgage before the end of the term could result in a fairly hefty prepayment penalty. However, closed mortgage tend to have significantly lower interest rates than open products, making them much more attractive to the average homebuyer if no major changes are anticipated in the near future.
An open mortgage allows you to make a lump sum payment at any time. In fact, this type of mortgage can be paid off entirely prior to maturity without penalty. An open mortgage can be a good choice if you’re planning to sell your home in the near future. For instance, your current mortgage may come up for renewal just as you are putting your house on the market. An open term would be a good choice in this instance because if your home sells, the mortgage can be paid out without a hefty penalty that would eat into your proceeds. If your home doesn’t sell and you decide to take it off the market and stay a while longer, the open mortgage can be converted, also without penalty, to a closed term to lower your interest rate.
Open mortgages are a good option when a homebuyer may be expecting a large sum of money in the near future, such as an insurance or a divorce settlement or an inheritance. Choosing an open mortgage when initially purchasing the home would allow the homeowner to reduce the overall balance of the mortgage once the anticipated funds become available. Again, the open mortgage can then be converted to a closed mortgage to obtain a more attractive closed mortgage rate.
Finally, some choose an open mortgage because they want the flexibility to make large lump sum payments. A homeowner may receive several bonuses through out the year from their employer and like the idea of being able to apply these funds to their mortgage at will. If this is your reason for considering an open mortgage, but be sure to check on the prepayment options offered with the closed mortgages available to you. Prepayment privileges are actually quite a bit more generous than most people realize and sometimes these anticipated extra funds can fit within their limits.
For instance, one major lender offers the following pre-payment privileges with their closed mortgages – 15% lump sum each year, 15% increase to the monthly payments plus being able to double up the regular monthly payment. Based on a $250,000 mortgage with $1600 monthly mortgage payments, the numbers look like this:
15% lump sum – $37,500 per year
15% increase to monthly mortgage payment – $2880
Monthly payment double up – $19,200
Total prepayment amount allowed for one year – $59 580
Nearly $60,000 is quite alot of room for most of us in regards to extra payments over and above your regular mortgage payment. Be sure to have your mortgage broker do the math because a lower rate closed mortgage will save you thousands of dollars in the long run and just may offer the flexibility you’re looking for after all.
Another great option for home owners looking the ultimate in flexibility is a Home Equity Line of Credit.
Check tomorrows blog for more information on the HELOC product.