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What is a Closed Mortgage and How Does it Work?
While most Canadians are aware of the difference between a fixed and variable rate mortgage, not as many of us are aware of the differences between an open and closed mortgage.
If you're a homeowner with a mortgage, chances are pretty good that it's a closed mortgage. Open mortgages just aren't that popular in Canada. When you go to the bank to inquire about mortgage options, the bank probably will only present you with closed mortgages. In most instances closed mortgages make the most sense.
As its name suggests, a closed mortgage comes with restrictions. It has restrictions in terms of how much you can pay off during your mortgage term. With an open mortgage, you can pay off your mortgage in full during your mortgage term. This comes in handy if you're expecting a huge inheritance or if you're lucky and win the lottery. Not so with a closed mortgage. You'd likely face a costly penalty if you paid off your mortgage early.
You're probably wondering why anyone would anyone choose a closed mortgage over an open one. The main reason is to save money. Closed mortgages typically come at a lower interest rate than open mortgages. So unless you expect a huge cash windfall, you should almost always go with a closed mortgage over an open mortgage.
Closed mortgage tend to come with a lot more term options than open mortgages. You may be able to choose a closed mortgage at a term length of one year, two years, three years, four years, five years and 10 years, whereby you may only have a single term to choose from for an open mortgage.
Why You Might Choose a Closed Mortgage
Unless you're planning to pay off your mortgage in the near future, closed mortgages almost always make sense.
When choosing a closed mortgage, you'll have to make many decisions, including fixed versus variable and the length of your mortgage term.
Many Canadians shop solely for a mortgage based on the lowest mortgage rate. While your mortgage rate matters, it isn't everything. Other features to consider with a closed mortgage include prepayments, penalties and portability.
Closed mortgages have restrictions in terms of how much you're allowed to pay off your mortgage. However, most closed mortgages come with some prepayment privileges. Many homeowners assume every lender has the same prepayments, when that isn't the case. If you want to aggressively pay down your mortgage, then it makes sense to look for a lender with generous prepayment privileges. Lenders typically let you make extra lump sum payments and increase your mortgage payment to pay it down sooner. By taking advantage, you can save yourself a lot of money in interest over your mortgage term.
Closed mortgages come with penalties for breaking them early. You can help avoid them by choosing a mortgage that's portable. With a portable mortgage, you may be able to take your mortgage with you without paying a hefty mortgage penalty if you sell your existing home and buy a new home during your mortgage term.
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Written by:
Amy Orr
Amy Orr is a professional writer and editor with over 10 years of experience in the Canadian, U.S. and U.K. financial markets. She has written for numerous publications on topics as diverse as economic literacy, corporate finance, and technical analysis of numerical data. Prior to transitioning to full-time writing, she worked in the hedge fund sector. Her academic background is astrophysics, and she has a Masters in Finance from the University of Edinburgh Business School.
Reviewed by:
Jenna West
Jenna West is Smarter Loans' in-house financial writer and content director. She has been covering the Canadian FinTech and finance industry since 2017, including financial trends analysis, industry surveys, regulatory updates and changes in Canadian consumer behaviour when it comes to finance.
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