Mortgage Basics

Open vs Closed Mortgages

Open vs Closed Mortgages
Written by
  • Ashley Howard
| 22 July 2024
Reviewed, 27 September 2024
Share:

Table of contents

    If you are considering buying a home or currently have a mortgage that needs to be renewed or refinanced, one of the choices you will have to make is which type of mortgage to opt for. There are various mortgage options, such as open or closed, fixed or variable, and terms varying from 6 months to 10 years, all designed to provide a solution for every borrower’s financing needs. 

    If you’re considering whether to go for an open or closed mortgage, it’s important to look at what each type of mortgage offers and the advantages and disadvantages of each option. Choosing the one most suitable for your immediate and future needs can help you save the most on your mortgage.

    Key Takeaways

    • Closed mortgages have more attractive interest rates but place restrictions, charging a prepayment penalty if you need to make changes during the term. 
    • Open mortgages have higher interest rates but allow you to make changes during the term without penalty. 
    • The choice between open and closed will depend on your situation and how much flexibility you need over the term.

    Popular Mortgage Rates

    Fixed
    Variable
    in

    0.00%5 Year Fixed

    Get Rates

    0.00%3 Year Fixed

    Get Rates
    Check more rates

    What Is a Closed Mortgage?

    Closed mortgages have fixed terms and conditions for the entire term you select. Once the mortgage contract is signed, these terms and conditions can’t be modified without facing penalties for breaking the term early, which could be considerable. 

    Closed mortgages offer limited flexibility. Most lenders provide prepayment options, such as the ability to make payments up to a certain percentage of the original mortgage amount without penalty. However, if you want to make additional prepayments, pay off the mortgage in full, refinance, or make any other changes to the mortgage before the end of the term, you will be required to pay prepayment penalties. 

    The tradeoff for having limited flexibility is the lower interest rates closed mortgages offer borrowers. Lenders are more willing to offer better rates as the limited flexibility discourages borrowers from breaking the mortgage agreement or making extra payments. 

    Prepayment Penalties

    Prepayment penalties for closed fixed-rate mortgages are calculated as the interest rate differential (IRD) or 3 months of interest, whichever is highest. Because of how penalties are calculated for fixed rates, breaking your mortgage closer to the beginning of the term will mean you incur higher penalties than you would toward the end. Variable-rate closed mortgages are based on 3 months of interest. 

    Advantages and Disadvantages

    The advantages of a closed mortgage include lower interest rates than open mortgages. Prepayment privileges are based on a percentage of the original mortgage amount and may vary by lender. 

    The disadvantages of a closed mortgage include limitations on how much you can prepay without a penalty and prepayment penalties for breaking the mortgage before the end of the term or making any other changes to the mortgage if they exceed what is outlined in your mortgage contract. 

    What Is an Open Mortgage?

    Open mortgages allow you to change your mortgage without worrying about prepayment penalties. Even though you still have a set term for the mortgage, you are not required to wait until the end of the term to make adjustments.  

    Open mortgages offer greater flexibility. You can make extra payments without restrictions, adjust your payment schedule, refinance, pay off, or break the mortgage before the end of the term without penalty. 

    The tradeoff for greater flexibility is higher interest rates. Lenders charge a higher premium for allowing borrowers to make unlimited prepayments or pay off the mortgage before the end of the term without penalties. 

    Advantages and Disadvantages

    The advantages of an open mortgage include no penalties for increasing regular mortgage payments, frequency, prepaying, or paying off the mortgage. Additionally, there are no penalties for refinancing to change the amortization; however, some lenders may charge a small fee for setting up a new mortgage. 

    The disadvantages of an open mortgage include higher interest rates than closed mortgages. If you don’t use an open mortgage’s flexibility, the higher interest rate can result in higher costs for no additional benefits. 

    How to Choose Between Open and Closed Mortgages

    Closed mortgages are ideal for homeowners who plan to stay in their homes for the duration of the mortgage. They are also suitable choices for those without the additional cash flow to make prepayments beyond what is stated in the mortgage agreement. In general, closed mortgages typically offer enough flexibility for the average borrower. 

    Open mortgages are ideal for homeowners who expect to make additional prepayments or pay off their mortgage before the end of the term. Homeowners who may want to sell before the end of the term may also consider an open mortgage if the cost savings from avoiding prepayment penalties are more than the higher interest rates they will pay. 

    If you anticipate your financial situation changing soon, like receiving an inheritance, selling another property, or experiencing a significant wage increase, and you intend to use some of this additional cash flow toward your mortgage, an open mortgage may be most suitable. However, ensure the amount you put toward the mortgage exceeds your lender’s prepayment privileges on a closed mortgage. Otherwise, the interest-carrying costs from a higher rate may not make sense.  

    Frequently Asked Questions

    What happens if I break a closed fixed-rate mortgage? 

    If you break a closed fixed-rate mortgage, you will be charged a prepayment penalty of either the interest rate differential (IRD) or 3 months of interest, whichever is higher. If you have a restricted fixed-rate mortgage, you may pay a penalty calculated as a percentage of the remaining balance instead. Depending on the lender, there may also be an additional restriction preventing you from paying off your mortgage without having a bona fide sale.

    What happens if I break a closed variable-rate mortgage?

    If you break a closed variable-rate mortgage, you will be charged a prepayment penalty of 3 months of interest. If you have a restricted variable-rate mortgage, you may pay a penalty calculated as a percentage of the remaining balance instead. Depending on the lender, there may also be an additional restriction preventing you from paying off your mortgage without having a bona fide sale.

    Can I convert an open mortgage to a closed mortgage or a closed mortgage to an open mortgage?

    You can convert an open mortgage to a closed mortgage at any time without penalty. If you want to convert from a closed mortgage to an open mortgage, you must pay a prepayment penalty or wait until you reach the end of your term.

    What are the available terms for open and closed mortgages?

    Open mortgages are typically short-term, with 6-month or 1-year terms on fixed mortgages and 5-years on variable. Closed mortgages have a much more extensive range of terms, with 6-month, 1, 2, 3, 4, 5, 6, and 10-year terms on fixed mortgages and 3 or 5 years on variable.

    Final Thoughts 

    Deciding between an open or closed mortgage is a choice that can significantly impact your finances. While closed mortgages typically have lower interest rates, there is the risk of steep penalties if you need to make changes before the end of your term. While open mortgages offer greater flexibility to accommodate changing financial circumstances, the increased borrowing costs may not compensate for the added flexibility if you are not taking full advantage of the features. 

    Consult with a mortgage professional to evaluate if an open or closed mortgage is most suitable for your mortgage solution.