The cheapest-looking mortgage is not always the cheapest one to live with. A closed mortgage may offer a lower interest rate, but an open mortgage gives you considerably more freedom if you want to repay the debt before the term ends. An open mortgage allows you to make extra payments or pay off the mortgage early without a prepayment penalty. A closed mortgage limits penalty-free prepayments to what your contract permits. In return for less flexibility, closed mortgages typically have lower interest rates than open mortgages with similar terms.
- Open vs. Closed Mortgage at a Glance
- How an Open Mortgage Works
- How a Closed Mortgage Works
- What Happens When You Pay More Than a Closed Mortgage Allows?
- What If You Need to Break the Mortgage?
- Open vs. Closed Is Separate From Fixed vs. Variable
- How to Choose Between an Open and Closed Mortgage
- Other Questions About Open and Closed Mortgages
Open vs. Closed Mortgage at a Glance
| Feature | Open Mortgage | Closed Mortgage |
|---|---|---|
| Extra principal payments | Unrestricted without a prepayment penalty | Subject to the contract’s prepayment rules |
| Paying off the mortgage early | No prepayment penalty | A penalty may apply |
| Breaking the mortgage | No prepayment penalty | Normally triggers a penalty |
| Interest rate | Typically higher | Typically lower for a similar term |
| Flexibility | Greater | More restricted |
Those differences make the choice less about which mortgage type is universally better and more about whether paying extra for flexibility serves a purpose. Someone expecting to keep the same mortgage until maturity faces a different calculation from someone already expecting a sale or large early repayment.
How an Open Mortgage Works
With an open mortgage, you can put additional money toward the principal without a prepayment penalty. You can also repay the entire balance before the term expires without that charge.
That freedom can be useful when you expect the mortgage to be temporary. You might plan to sell the property soon or anticipate having enough money to make a substantial repayment. Open mortgages typically charge higher interest rates than comparable closed mortgages, so the flexibility comes at a cost.
We would not treat that higher rate as worthwhile simply because unrestricted repayment sounds attractive. The relevant question is whether you have a realistic reason to use it. The circumstances covered by when an open mortgage may make sense are therefore more important than flexibility by itself.
How a Closed Mortgage Works
A closed mortgage restricts how much extra principal you can repay during the term without a charge. Closed mortgages typically offer lower interest rates than open mortgages with similar terms.
The word “closed” can sound more restrictive than it really is. A contract may include prepayment privileges that let you increase regular payments or make lump-sum payments without a penalty. However, the permitted amount, timing and conditions vary between lenders, and not every closed mortgage offers the same privileges. Mortgage prepayment rules for federally regulated lenders also require the agreement to disclose these details.
For someone who expects to keep the mortgage for the entire term, a closed mortgage’s permitted prepayments may already provide all the flexibility needed. In that situation, paying a higher rate for unrestricted repayment may offer little practical value.
What Happens When You Pay More Than a Closed Mortgage Allows?
Going beyond the prepayment privileges in a closed mortgage can trigger a prepayment penalty. A charge may also arise if you repay the entire mortgage, break the contract or move to another lender before the term ends.
Prepayment privileges are contract-specific. They may let you increase scheduled payments, make lump-sum payments, or both. Most lenders impose annual limits, and unused prepayment room typically cannot be carried forward into a later year. Prepayment privileges and penalties explain the details worth checking before making an additional payment.
This is the part we would examine closely when comparing closed mortgages. A low advertised rate tells you nothing about how easily you can reduce the balance ahead of schedule.
What If You Need to Break the Mortgage?
Life does not always cooperate with the mortgage term you signed. Selling your home, refinancing or changing lenders can require you to end the existing contract earlier than planned.
An open mortgage can be broken without a prepayment penalty. Breaking a closed mortgage normally results in one, and the penalty can cost thousands of dollars. Administration, appraisal, discharge or other applicable fees can add to the cost. Breaking a mortgage contract can therefore involve more than simply repaying the outstanding principal.
A lender can provide the actual prepayment charge that would apply to your mortgage. Getting that figure before refinancing or selling gives you something concrete to compare against the financial benefit of leaving the existing contract.
Open vs. Closed Is Separate From Fixed vs. Variable
Open and closed describe prepayment flexibility. Fixed and variable describe interest-rate behaviour. They are separate mortgage features.
For example, a mortgage can be both variable-rate and closed. The interest rate can change while restrictions still apply to how much principal you may repay early. Comparing fixed mortgage rates with variable mortgage rates therefore answers a different question from choosing between an open and closed contract.
Keeping the two decisions separate makes mortgage offers much easier to read. First determine how much repayment flexibility you need. Then evaluate the interest-rate structure available within the mortgage products that meet that requirement.
How to Choose Between an Open and Closed Mortgage
Start with what you reasonably expect to happen before maturity. A closed mortgage may fit when you expect to keep the loan for its full term and its prepayment privileges comfortably cover any extra payments you plan to make. An open mortgage becomes more relevant when early repayment is sufficiently likely that avoiding a future penalty could justify its higher rate.
Before signing, check the mortgage type, rate, prepayment privileges and penalty provisions together. Federally regulated lenders must disclose whether the mortgage is open or closed and provide information about applicable prepayment privileges and charges. Mortgage disclosure requirements make those terms available before you commit.
Our preference would be to pay for flexibility only when there is a credible reason to need it. Otherwise, compare closed mortgages carefully enough to find one whose prepayment privileges fit your plans rather than assuming every closed mortgage is equally restrictive.
Other Questions About Open and Closed Mortgages
Can you pay off a closed mortgage when the term ends?
You can repay the remaining balance at the end of the term instead of renewing. Waiting until the term ends can avoid the prepayment penalty that might have applied to an earlier payout.
Can you switch from an open mortgage to a closed mortgage?
Some lenders may offer conversion or renegotiation options, but the available choices depend on the specific mortgage contract. Check those terms with the lender before assuming you will be able to switch later.
Can a closed mortgage still be paid off faster?
A closed mortgage can be paid down faster by using the extra-payment options permitted by its contract. Depending on the mortgage, these may include lump-sum payments or increases to regular payments. Paying a mortgage off faster requires staying within the applicable prepayment limits if you want to avoid a penalty.
