Open and Closed Mortgages- what is the difference?
An open mortgage has the ultimate flexibility for a borrower as the mortgage can be paid down or off without any penalty. These mortgages are great for either a short term solution to avoid pre-payment penalties. The freedom in an open mortgage means that it will come with much higher interest rate as the lender has a shorter time to make a profit from the interest paid.
A secured line of credit (often called a HELOC) is a type of open mortgage, which is a revolving line of credit secured against your property. The interest rate is most often set as a prime plus a set interest rate amount and fluctuates with prime. Secured lines of credits offer home owners the flexibility to pay as little as the minimum interest only payment or to pay as much toward their balance at any time. Some secured line of credits can be tied to a mortgage on the home and some people choose to put their entire mortgage (up to 65%) in a line of credit.
A closed mortgage locks the mortgage in for a set term which is the length of a current mortgage agreement with a particular lender. Terms can be anywhere between 6 months to 10 year terms. Mortgage lender agreement often have generous pre-payment privileges, however in a closed mortgage you are limited to how much you can put down on your mortgage amount and if you break your mortgage before your term is up there are penalties.
Within a closed mortgage term a buyer can choice between a fixed rate and a variable rate mortgage.
Fixed Vs Variable. Which is right for you?
Fixed rate mortgages offer you stability and consistency in payment amount because your payments will not change for the entire length of your mortgage term, and they are an equal amount every month. Fluctuations in prime rate will not affect you which means you do not have to consider the possibility of increasing mortgage payments to account for how the changing rates affect your payment to interest and principal. This is the reason that fixed rates are set higher than variable rate, as mortgage lenders need to account for the possibility of rising interest rates over the course of your term. If during the term of your mortgage interest rates drop, you will be paying more interest than a variable rate mortgage. If you break your fixed rate mortgage before your term, prepayment penalties are determined based on either an IRD payment or a 3 months interest charge which ever is higher.
Variable rate mortgages typically have a lower interest rate than a fixed rate mortgage because the rate fluctuates with Prime rate. The variable is the amount of interest discount from prime. For example prime minus .5%, where .5% is the variable in this example. The variable discount stay the same for the term (most often 3 or 5 years), but lender prime rates fluctuate based on what the Bank of Canada sets as the ‘overnight’ rate. When prime rate goes down more of your mortgage payment will go to pay down principal, when prime rate goes up more of your mortgage payment will go to pay down interest OR your bank may choose to increase or decrease your mortgage payment to reflect changes in prime. If you break your variable rate mortgage before your term, prepayment penalties are 3 months interest only- so this kind of mortgage is a better choice if you think there may be a chance you will break your mortgage. If you have a variable rate mortgage and worry about rising interest rates, most lenders allow you to convert to a fixed rate mortgage at current rates but keep in mind certain provisions will apply. Historically, variable rates are less expensive.
What does insured, insurable, uninsurable, conventional, and high ratio mean?
On top of a mortgage type, your mortgage will fit within certain guidelines and sometimes interest rates depending on the amount of down payment you have. Our blog Insured, Insurable and Uninsurable will help you understand the differences.