Closed v open mortgage: What’s more costly?
A closed mortgage only allows a limited amount of additional payments before you get hit with a penalty. Likewise, you’ll be required to pay a fee if you break any of the loan’s terms.
Many people think that it’s best to choose an open mortgage if they plan to pay off their mortgage early. However, some experts believe that this way of choosing may be inaccurate and could even unnecessarily increase the total cost of the loan.
Which is more costly?
Either of the two types of mortgages can be more costly than the other – it all depends on your current and future financial circumstances.
Open mortgages may give borrowers more flexibility, as well as the freedom to pay off loans early, but it does so in exchange for higher interest payments. This means you’ll be paying a higher amount regularly in exchange for the possibility that you’ll have enough extra money to put towards your mortgage repayments.
Closed mortgages, on the other hand, may charge a penalty for extra payments and paying off the loan early, but they also offer some of the lowest interest rates.
You’ll be paying your lender less money on interest even if you’re locked in to pay for a longer term. But any break in the terms of the loan, such as exceeding the allowable prepayment limit, would mean additional payment due to penalties.
To determine which type will cost you more money, you’ll have to compute how much your repayments are likely to be and how the penalties will be calculated for a closed mortgage.
Lenders generally compute the penalty as three times your monthly interest rate.
For instance, if you have a $300,000 home loan (closed mortgage) with a 2.95 per cent interest rate for 25 years, you will pay a total of $221,250 in interest over the full term of the loan ($737.5 monthly).
If you have an open mortgage with a higher interest rate at 3.75 per cent, you will pay a total of $281,250 in interest ($937.5 monthly).
If you break your closed mortgage, your penalty will be $2,212.5 on top of your full payment. Despite this penalty, a closed mortgage would still save you more money in the long run.
However, this does not apply to all loans.
An open mortgage may still save you more money if you avail the right features.
It’s best to discuss your financial circumstances and future plans with a broker so they can give you advice that is more appropriate to your circumstances.
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