Open vs. closed mortgages

An open mortgage gives homeowners the flexibility to pay off their mortgage at any time. A closed mortgage is little more strict -- if you pay it off before the mortgage term ends, you have to pay a penalty. So on top of choosing between variable and fixed rates, buyers also need to decide between open and closed mortgages.

Open mortgages give you the ultimate payment flexibility

The entire mortgage balance can be paid off at any time without penalty. But open mortgage rates are usually variable and a little higher. You’ll likely end up paying the prime rate plus a substantial premium.

Fortunately, you can always move into a regular fixed rate mortgage if you decide variable interest rates aren’t a good fit for you. That’s what makes an open mortgage so appealing – you can pay it off or move to another product at any time.

Closed mortgages offer attractive interest rates

Closed mortgages generally have lower interest rates than open mortgages do, but borrowers get limited flexibility: you can’t pay off the loan without incurring a penalty. Most closed mortgages allow for accelerated payments of some kind, but each lender sets it own prepayment terms. Some lenders will let you double up your scheduled mortgage payments or pay an annual lump sum.

Nonetheless, with a closed mortgage you’re essentially agreeing to keep the loan for the entire term. Borrowers who sell their house because of a relocation or job loss can end up with less money than they anticipated because high break fees gobble up their equity.

What about prepayment penalties?

Break fees are generally either the sum of three months of interest on your mortgage or the interest rate differential (IRD), whichever is greater.

The IRD is the difference between what you would have paid in interest and what the bank can now make on the funds they lent you, based on the current rates, for the remainder of your term.

If you were paying the bank 5% interest and they can now only lend the money out for 3%, you have to pay back the difference. Of course, the more months left on your term, the greater the IRD penalty because the difference in interest is incurred for a longer period of time.

The IRD usually only applies to fixed rate mortgages. Unfortunately, today’s falling fixed interest rate environment means borrowers are almost guaranteed to pay the IRD, and that’s often a nasty surprise to Canadians who failed to read the fine print of their mortgage contract.

When you’re shopping for mortgages, use our powerful comparison tools to take a peek at rates for both open and closed mortgages.

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