Open Mortgage Definition
An open mortgage is a mortgage that permits 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.
Example
Mr. McGillicuddy has recently purchased a house worth $500k and took an open mortgage worth $300k. As Mr. McGillicuddy is looking to liquidate some assets in the near future, he wants the flexibility to make large lump sum payments towards his mortgage. Mr. McGillicuddy then sold his vacation property for $300k and applied the entire amount to pay out his mortgage without penalty.
Mr. McGillicuddy made a good decision to go with an open mortgage as compared to a closed mortgage where he would have been limited to a 10%-20% prepayment privilege and would have incurred a pre-payment penalty. In this case, the higher interest rate on the open mortgage was worth paying over the penalty.
Advantages of an Open Mortgage
Open mortgages can be very beneficial for people with income that varies, such as many self employed borrowers. If a self employed individual receives an extra $5,000 it can then be applied to the mortgage principal without interest.
It may also be beneficial for people who are expecting an increase in income in the future, and who will desire to repay as much of their mortgage as fast as possible. An open mortgage will allow the borrower to do so, without penalty, and the more applied to principal, the less interest the borrower will eventually pay on the mortgage.
As in the example above, an open mortgage has significant short term advantages to those individuals who know they will be making a large lump sum payment to their mortgage, however are just unsure of the timeline.
Disadvantages of an Open Mortgage
The main disadvantage of an open mortgage is that the interest rate is generally at least 1% higher than a fixed term, closed mortgage. A borrower planning to pay extra towards the principal may offset the higher interest rate through reductions in principal. If this type of borrower has a fixed budget and cannot make additional principal payments, a lower rate fixed mortgage may make better economic sense.
At First Foundation, we understand that a thorough discussion of your current financial situation, as well as a projection of your future income, is the best way to determine which type of mortgage is best for you. With full analysis of your financial needs, we can provide you with the right mortgage product.
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If you are interested in learning more about open mortgages, please feel free to contact us today!