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As you plan to take out a mortgage, you need to know the types of mortgage terms available. Knowing these options will help you select the most suitable mortgage product that satisfies your needs.
Let’s start with the open-term mortgage.
There are two types of mortgage terms; open term and closed term. Mortgages with these terms are called open term mortgages and closed term mortgages.
A mortgage term is the length of your contract with a specific lender. Mortgage terms range from six months to 10 years. The most popular term in Canada is the 5-year mortgage term.
The main difference between these two mortgage term types is how you are allowed to prepay the mortgage loan, that is, paying down or paying off the mortgage loan before its maturity.
An open-term mortgage allows you to pay above the required periodic payment amount or even pay off the entire mortgage loan at any time during the term without incurring a penalty. There is no repayment restriction with this form of mortgage loan.
You enjoy the flexibility of paying down your mortgage loan fast, thus reducing your interest expense over the mortgage term with an open-term mortgage.
Also, with an open-term mortgage, you can refinance your mortgage or move it to another lender anytime within the term without incurring a prepayment penalty.
The payment flexibility of open-term mortgages comes at a high-interest rate cost.
Most Canadians don’t use this type of mortgage product except needed.
The repayment period for open-term mortgages is shorter than that of closed-term mortgages. The term is anything between six months to five years.
Although these kinds of mortgages are uncommon, they give you the option of repaying your loan over a shorter period rather than a more extended period.
With a closed-term mortgage, you can repay your mortgage above the regular monthly amount without incurring a prepayment penalty. Some closed-term mortgage loan products have a prepayment privilege, simply an option to repay your mortgage up to a specific point above your regular monthly or annual payment without a penalty.
The prepayment privilege is quoted as a percentage of your outstanding mortgage balance. Suppose you have a stated prepayment privilege at 15%, which means you can increase your regular monthly payment amount by 15% without incurring a penalty.
The prepayment privileges for closed-term mortgages differ from lender to lender. Therefore, you should check your prepayment privilege with your lender if you choose to get a closed-term mortgage.
There are also longer-term options for closed mortgages. You can get a term from 6 months to 10 years. Large populations of those seeking mortgages in Canada don’t intend to pay off their mortgage in the short term, which is why they prefer closed mortgage contracts.
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Prepayment Penalty: You may have to pay a hefty penalty if you choose to repay more than your prepayment privilege or pay off your mortgage entirely.
If you sell your home and put the money into your mortgage account, you will still have to pay the hefty penalty. However, you can escape the penalty if you port your mortgage to your new home. That is, as long as the terms and conditions of your mortgage allow for that.
The high penalty might make it challenging to take advantage of the low rate with a closed-term mortgage.
Flexible Repayment: You pay off all or part of your outstanding mortgage loan without incurring a prepayment penalty.
High Mortgage Rate: Open-term mortgages come with high mortgage rates and costs. The lenders charge this extra interest to compensate for the expected interest income loss when you pay off the loan before the planned maturity date.
When determining whether to opt for a closed or open mortgage, it is essential to consider all the factors. You cannot decide on the best mortgage based on only one aspect. So many factors are in play, and it will be essential to consider them before deciding.
Here is a summary of events that may lead to you choosing any of the two mortgage options. You can opt for an open mortgage if
The open and closed mortgage options will depend on an individual and their circumstances. The best thing is to understand how each operates to make wise decisions based on your financial plan and state.