The mortgage terms “open” and “closed” refer to how flexible the rules are for paying your mortgage. Closed mortgages offer lower interest rates, but they’re also less flexible if you want to pay down your loan sooner (doing so can result in prepayment penalties). Open mortgages have greater flexibility because they allow you to put as much money towards your mortgage as you’d like, but they often come with higher interest rates.
So which do you choose – an open vs. closed mortgage? Getting the home loan that works best for you is key to decades of stress-fee mortgage payments, so this is no small decision.
Here’s everything you need to know about the differences between the 2 types of mortgages.
Key Takeaways
- Open mortgages offer you flexible prepayment options but typically have higher interest rates.
- Closed mortgages have lower interest rates and predictable payments, but lack flexibility around prepayments.
- You may be well suited to an open mortgage if you want to pay off your mortgage sooner, or plan to move your mortgage or sell your property in the short term.
- A closed mortgage is a wise choice for those who plan to stay in their property long-term and prefer stable mortgage payments.
What is a closed mortgage?
A closed mortgage has specific conditions that dictate how much your monthly payments will be, which the bank uses to calculate how much interest you’ll pay over the course of the term.
You can usually pay a certain amount above your normal payments, called a “prepayment privilege,” but anything above that may result in an expensive penalty.
So say you receive a lump sum of money and want to put it towards your mortgage, or you want to move your mortgage to a new lender before the end of your term. With a closed mortgage, you’ll face prepayment penalties in these cases.
Essentially, the bank is making sure they’ll make a certain amount of money off your loan by locking you into a predefined time frame. The tradeoff is you’ll usually be offered lower interest rates in exchange for lower flexibility.
What is an open mortgage?
An open mortgage has a lot fewer rules governing how much you can put towards your payments.
You’ll obviously be expected to hit a certain minimum payment every month, but it gives you a lot more room to add extra money whenever you’re able to. And you can pay off as much as you want without worrying about prepayment penalties.
This means you could potentially save a lot of money in interest over the long term by having the flexibility to tackle more of your principal earlier on in your mortgage amortization period. The less principal you have, the less interest youll pay.
But on the flip side, you’ll usually be facing higher interest rates, so you’ll need to make sure that’s worth the extra flexibility.
The pros and cons of an open vs. closed mortgage
Both open and closed mortgages have their ups and downs. Let’s lay these out in a way that’s a bit easier to absorb.
| Type of mortgage | Open mortgage | Closed mortgage |
|---|---|---|
| Pros | * More flexibility, especially in terms of prepayments * Easier to move your mortgage around | * Most popular option, so you’ll have a greater selection of terms to choose from * Lower interest rates since the bank can count on your regular payments |
| Cons | * Usually have higher interest rates to make up for flexibility * Less options from lenders | * Steep prepayment penalties if you pay too much extra towards your payments * Also hit with penalties if you need to move your mortgage before your term is done |
When it comes down to it, it’s really a difference between flexibility vs. overall cost. But you can’t tell the future, so how do you decide which is better for you?
When to choose an open mortgage
First, open mortgages. If you can relate to one or more of the following scenarios, you may have found your mortgage match:
- You’re expecting a lump sum payment before your term is over. If you think you’re in line for a large inheritance, bonus from work, or other lump sum payment and you’re planning on putting most of it towards your mortgage – an open rate mortgage is your better option. This way you won’t have to worry about prepayment penalties.
- You’re planning on moving again before your term is over. If you know that the home you’re buying is temporary, then an open mortgage will make the process of moving in a couple years much easier (and cheaper).
- You want to put extra cash towards your payments when you can. If you hate the thought of all that interest piling up on your mortgage, then putting extra cash towards larger monthly payments is a good way to tackle more of your principal, which means less interest overall. An open mortgage would let you do this without worrying about keeping within prepayment limits.
- You’re expecting your household income will go up before the term is over. If you think you or your spouse will start earning way more money over the course of the term and you’d like to increase your mortgage payments in tandem with this increase, an open mortgage may be better suited for this scenario.
When to choose a closed mortgage
But closed mortgages are much more popular than their open counterparts, so what scenarios make it a better idea to opt for the closed option?
- You’re buying your forever home. If you know you want to live in this house for the rest of your independent life, then going with a closed mortgage can make your mortgage payments stable and predictable for the decades to come.
- You’d rather put future lump sum payments or income increases towards other uses. If your predicted income increases or inheritances already have a future place in your investments or travel fund, then maybe you don’t need to be so flexible with your mortgage payments. In this case, opting for a closed mortgage may be your better option.
- You want lower interest rates. If you just want to save the most on your mortgage as possible, then locking in lower interest rates could be a better way of making sure that happens. Sure lump sum payments could save you money in the long run, but if you’re not sure you’ll actually make those payments, a closed mortgage could be cheaper for you.
So which is better when comparing open vs. closed mortgages?
Basically what it boils down to is how much flexibility you’ll need.
Is this your forever home and you’re happy to just settle into set payments for the next 25 years?
Or will you be moving around and optimizing your payments to save as much money as you can over the course of your mortgage?
What has your experience been with open vs. closed mortgages? How did you choose one or the other?
Let us know in the comments below!
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What’s the difference between an open vs. closed mortgage?
The major difference between the 2 types of mortgages is how flexible you can be with your payments. An open mortgage allows you to prepay as much as you want, but often has higher interest rates. On the other hand, a closed mortgage usually has stricter payment rules, but with lower interest rates.
When should I get an open mortgage?
An open mortgage could be a good choice for someone who is looking to pay off their mortgage as fast as they can, or planning to move and/or change lenders before their term is over.
When should I get a closed mortgage?
The major selling point of a closed mortgage is that it has lower interest rates, which appeals to a lot of people. If you don’t think you need the extra flexibility that an open mortgage offers, then a closed mortgage is the more popular choice.
What is a closed variable rate mortgage?
A closed variable rate mortgage is a type of mortgage where the interest rate on your loan fluctuates according to the prime rate. With this type of mortgage, your payments could go up or down. Comparatively, a closed fixed rate mortgage offers you a consistent interest rate over a specified term.
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