When it comes to mortgages, there are a variety of options available to you. It’s up to you and your lender to do the research and find out which option is the best fit for you. But whether you end up with a fixed-, variable- or adjustable-rate mortgage, you will also have to choose between and open and closed mortgage. Here’s what that means.
An Open Mortgage. This option provides the most flexibility in that it will allow you to pay off your mortgage early or make large prepayments without incurring a penalty. This is ideal for a long-term mortgage situation, where your finances and lifestyle are likely to change overtime. While it sounds ideal, the drawback is that it usually comes with higher interest rates than a closed mortgage, to make up for the lender potentially losing out if the mortgage is paid off earlier than anticipated.
A Closed Mortgage. This kind of mortgage has more rules and much less flexibility than an open mortgage. If you break rules by paying off the mortgage early, reducing the amortization period or changing mortgages, you will be penalized for it with break fees. As restrictive as this may seem, the benefit is that the interest rate will be notably lower than it is in an open mortgage. Different lenders will also have different rules, so you might be able to make a lump sum prepayment up to a certain amount depending on the lender. The fee for breaking your mortgage will depend on whether you have a fixed- or variable-rate mortgage. The latter is usually three months’ worth of interest, while the former is generally either three months interest or the sum of the Interest Rate Deferential (IRD)—the amount you would have paid had you stayed until the end of your agreed term, minus your lender’s current rate on the money they lent you.
Which is best for you? It depends entirely on your personal and financial situation and how flexible that will be in the future. If you don’t require the flexibility an open mortgage provides, a closed mortgage is a safer bet as it offers lower interest rates. On the other hand, if you know your future plans are unpredictable, an open mortgage might be the safer choice. If you think you might want or need to sell sooner than expected, an open mortgage will allow you to do so with less penalties.