Mortgages 101: Understanding the Differences Between ‘Open’ and ‘Closed’ Mortgages
Marci • July 28, 2014
If you’re planning to buy a home this year, you’re probably already investigating mortgages and the different options available to you. The reality is that for many families, home ownership is simply out of reach without taking on a mortgage. Mortgages come in a variety of forms, and it’s important to understand how they differ. ‘Open’ and ‘closed’ mortgages are two options you’ll often encounter when seeking funds to buy your home. Here’s what you need to know about these two different mortgage types, and what they mean for your financial future.
Open Versus Closed: Pay Periods and Penalties
The main difference between open and closed mortgages is that open mortgages allow early repayment, while closed mortgages do not. Every mortgage has a set repayment period that dictates what your payment schedule will be and when you will have paid your debt in full. A closed mortgage has a set repayment term, and full repayment of your mortgage prior to the end of this term will result in a penalty fee. In contrast, open mortgages offer repayment terms ranging from six months to several years, meaning you can repay your mortgage at your discretion without incurring penalties.
There is, though, one exception to the payment penalties for closed mortgages. Although you may not repay a closed mortgage in full prior to the end of the term, most of he time, you may remit up to 20 percent of the original mortgage amount per year by using a prepayment option. Talk to your mortgage advisor for a full explanation of how prepayment can expedite the mortgage repayment process.
Closed Mortgage Prepayment Penalties
If you decide to refinance or sell the property prior to the closed mortgage maturity date, you will incur a prepayment penalty equal to either three months’ interest or the Interest Rate Differential.
In the former case, three months’ interest is payable in one lump sum, while IRD applies only if current interest rates are below prevailing rates on the date of initial loan disbursement.
IRD is calculated by multiplying the difference between both percentage interest rates by outstanding balance and then by your remaining loan term. Thus, the earlier you repay the greater penalty you will incur in both the above scenarios.
That Pesky Interest: How Your Mortgage Type Changes Your Interest Rate
A typical mortgage will have an interest rate that is either fixed or variable. If your mortgage has a fixed interest rate, you pay a set percent of interest every month for the duration of your mortgage – and this amount never changes. If your mortgage has a variable interest rate, then the amount of interest you pay will fluctuate according to changes in the prime rate.
Regardless of whether your interest rate is fixed or variable, you will pay a different amount of interest for a closed mortgage than for an open mortgage. Open mortgages tend to have higher interest rates than closed mortgages, because in an open mortgage there is a lower probability that you will have the mortgage for the full term.
Open or Closed: Which is the Better Option?
Ultimately, deciding whether to opt for an open or closed mortgage will depend on your own personal needs and your plans for your financial future. If you have a limited income and require a set repayment schedule, a closed mortgage will give you the low interest rate and small monthly payment that you need. If, however, you have a higher amount of cash on hand and you expect to repay your mortgage very soon, an open mortgage will allow you to save a great deal of money in interest that you would have paid over the long term. Just be aware, however, that your interest rate may fluctuate over time – possibly making your monthly payments significantly higher than expected. The main consideration to make in deciding whether an open or closed mortgage is right for you is how long you plan to be paying off your mortgage. If you expect to pay off your mortgage extremely soon, an open mortgage is ideal. Otherwise, a closed mortgage is the safer option. Buying a home is a major purchase, and the mortgage you choose is one that will likely stay with you for most of your life. Open and closed mortgages offer vastly different terms that will appeal to different buyers, and it can be difficult to determine which option is your best bet. For more information about your mortgage options, and to discover which kind of mortgage will best meet your needs, contact our office today.
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Alternative lending refers to any lending practices that fall outside the normal banking channels. Alternative lenders think outside the box and offer solutions to Canadians who wouldn’t otherwise qualify for traditional mortgage financing. In an ideal world, we’d all qualify for the best mortgage terms available. However, this isn’t the case. Securing the most favourable terms depends on your financial situation. Here are a few circumstances where alternative lending might make sense for you. Damaged Credit Bad credit doesn’t disqualify you from mortgage financing. Many alternative lenders look at the strength of your employment, income, and your downpayment or equity to offer you mortgage financing. Credit is important, but it’s not everything, especially if there is a reasonable explanation for the damaged credit. When dealing with alternative lending, the interest rates will be a little higher than traditional mortgage financing. But if the choice is between buying a property or not, or getting a mortgage or not, having options is a good thing. Alternative lenders provide you with mortgage options. That’s what they do best. So, if you have damaged credit, consider using an alternative lender to provide you with a short-term mortgage option. This will give you time to establish better credit and secure a mortgage with more favourable terms. Use an alternative lender to bridge that gap! Self-Employment If you run your own business, you most likely have considerable write-offs that make sense for tax planning reasons but don’t do so much for your verifiable income. Traditional lenders want to see verifiable income; alternative lenders can be considerably more understanding and offer competitive products. As interest rates on alternative lending aren’t that far from traditional lending, alternative lending has become the home for most serious self-employed Canadians. While you might pay a little more in interest, oftentimes, that money is saved through corporate structuring and efficient tax planning. Non-traditional income Welcome to the new frontier of earning an income. If you make money through non-traditional employment like Airbnb, tips, commissions, Uber, or Uber eats, alternative lending is more likely to be flexible to your needs. Most traditional lenders want to see a minimum of two years of established income before considering income on a mortgage application. Not always so with alternative lenders, depending on the strength of your overall application. Expanded Debt-Service Ratios With the government stress test significantly lessening Canadians' ability to borrow, the alternative lender channel allows expanded debt-service ratios. This can help finance the more expensive and suitable property for responsible individuals. Traditional lending restricts your GDS and TDS ratios to 35/42 or 39/44, depending on your credit score. However, alternative lenders, depending on the loan-to-value ratio, can be considerably more flexible. The more money you have as a downpayment, the more you’re able to borrow and expand those debt-service guidelines. It’s not the wild west, but it’s certainly more flexible. Connect anytime Alternative lending can be a great solution if your financial situation isn’t all that straightforward. The goal of alternative lending is to provide you with options. You can only access alternative lending through the mortgage broker channel. Please connect anytime if you’d like to discuss mortgage financing and what alternative lending products might suit your needs; it would be a pleasure to work with you.
If you need a mortgage, working with an independent mortgage professional will save you money and provide you with better options than dealing with a single financial institution. And if that is the only sentence you read in this entire article, you already know all you need to know. However, if you’d like to dig a little deeper, here are some reasons that outline why working with an independent mortgage professional is in your best interest. The best mortgage is the one that costs you the least over the long term. An independent mortgage professional can help you achieve this. Mortgages aren’t created equally. Oftentimes slick marketing leads us to believe the lowest “sticker price” is the best value. So when it comes to mortgage financing, you might assume the mortgage with the lowest rate is the best option. This isn’t always the case. When considering a mortgage, your goal should be to find the mortgage that will cost you the least amount of money over the total length of the mortgage. There are many factors to consider, such as your specific financial situation, the rate, initial term length, fixed or variable rate structure, amortization, and the penalties incurred should you need to break your mortgage early; the fine print matters. An independent mortgage professional can walk through all these factors with you and will help you find the mortgage that best suits your needs. Sometimes taking a mortgage with a slightly higher rate can make sense if it gives you flexibility down the line or helps you avoid huge payout penalties. Working the numbers with an independent mortgage professional will save you money in the long run instead of just going with what a single lender is offering. Save time by letting an independent mortgage professional find the best mortgage product for you. Let's face it, getting a mortgage can be challenging enough on its own. Everyone’s financial situation is a little different and making sense of lender guidelines is a full-time job in itself. So instead of dealing with multiple lending institutions on your own, when you work with an independent mortgage professional, you submit a single mortgage application that is compared to the lending guidelines of various mortgage lenders. This will save you time as you don’t have to go from bank to bank to ensure you’re getting the best mortgage. Simply put, an independent mortgage professional works for you and has your best interest in mind, while a bank specialist works for the bank and has the bank's best interest in mind. It’s no secret that Canadian banks make a lot of money. It seems every quarter they turn billions of dollars in profit (despite the economic environment). They do this at the expense of their customers by charging as much interest as they can and structuring mortgages to their benefit. It’s all about the alignment of interest. Bank employees work for the bank; the bank pays them to make money for the bank. In contrast, independent mortgage professionals are provincially licensed to work for their clients and are paid a standardized placement or finder’s fee for matching borrowers with lenders. When you work with a single bank, you only have access to the products of that bank. When you work with an independent mortgage professional, you have access to all of the lenders that mortgage professionals have relationships with and all their products. Working with an independent mortgage professional will save you money, time, and provide you with better mortgage options. Plus, you have the added benefit of working with a licensed professional looking out for your best interest, providing you with the best possible advice. If you’d like to know more or to discuss mortgage financing, please connect anytime; it would be a pleasure to work with you.
Chances are, buying a home is one of the most important financial decisions you’ll make in your life. And as mortgage financing can be somewhat confusing at the best of times, to alleviate some of the stress and to ensure your home purchase goes as smoothly as possible, here are six very high-level steps you should follow. While it might seem like the best place to start the home buying process is to browse MLS on your phone and then contact a Realtor to go out and look at properties, it’s not. First, you’re going to want to work with a licensed independent mortgage professional. When you work with an independent mortgage professional, instead of working with a single bank, you’ll be working with someone who has your best interest in mind and can present you with mortgage options from several financial institutions. The second step in the home buying process is to put together a mortgage plan. Unless you have enough money in the bank to buy a home with cash, you’re going to need a mortgage. And as mortgage financing can be challenging and not so straightforward, the best time to start planning for a mortgage is right now. Don’t make another move until you discuss your financial situation with an independent mortgage professional. It’s never too early to start planning. As part of your mortgage plan, you’ll want to figure out what you can afford on paper, assess your credit score, run some financial scenarios, calculate mortgage payments, and have a clear picture of exactly how much money is required for a downpayment and closing costs. You’ll also be able to discuss which mortgage product is best for you, considering different mortgage terms, types, amortizations, and features. Now, what you qualify to borrow on paper doesn’t necessarily mean you can actually afford the payments in real life. You need to consider your lifestyle and what you spend your money on. Understanding your cash flow is the key. Make a budget to verify you can actually afford your proposed mortgage payments and that you have enough funds to close on the mortgage. No one wants to be house-poor or left scrambling to come up with funds to close at the last minute. If everything looks good at this point, the next step will be to get a preapproval in place. Now, a pre-approval is more than just typing some numbers into a form or online calculator; you need to complete a mortgage application and submit all the documents requested by your mortgage professional. Only proceed with looking at properties when you’ve been given the green light from your mortgage professional. When you’ve found a property to purchase, you’ll work very closely with your mortgage professional to arrange mortgage financing in a short period of time. This is where being prepared pays off. As you’ve already collected and submitted many documents upfront during the preapproval process, you should be set up for success. However, remain flexible and provide any additional documentation required by the lender to secure mortgage financing. Once you have firm lender approval and you’ve removed conditions on the purchase agreement, don’t change anything about your financial situation until you have the keys. Don’t quit your job, don’t take out a new loan, or don’t make a large withdrawal from your bank account. Put your life into a holding pattern until you take possession of your new home. So there you have it, six steps to ensuring a smooth home purchase: Work with an independent mortgage professional. Put together a mortgage plan. Figure out what you can actually afford. Get a pre-approval. Provide the necessary documentation. Don’t change anything about your financial situation until you take possession. If you’d like to discuss your personal financial situation and find the best mortgage product for you, let’s work together. We can figure out a plan to buy a home as stress-free as possible. Please connect anytime; it would be a pleasure to work with you.
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MARCI DEANE
MORTGAGE BROKER
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The first step is to start a conversation with me.
