Open vs closed mortgage: what is the difference?

An open mortgage lets you repay all or part of the loan at any time with no penalty. A closed mortgage gives you a lower rate in exchange for limits on how much extra you can pay and a penalty if you break it.

The short version: almost all Canadian mortgages are closed. An open mortgage suits a short plan or a large lump sum coming soon.

How a closed mortgage works

Almost all Canadian mortgages are closed, because the rate is lower. You agree to a term, usually five years, and the lender lets you prepay only within set limits. Going beyond them, or ending the mortgage early, triggers a penalty.

Closed mortgages still allow some flexibility through prepayment privileges, which differ between lenders. Typical privileges let you:

• Pay an extra lump sum each year, often 10% to 20% of the original loan.
• Increase your regular payment by a set percentage, often 10% to 20%.
• Choose accelerated or more frequent payments.

How an open mortgage works

Open mortgages let you repay any amount at any time. They are usually offered for short terms such as six months or a year, and the rate is noticeably higher than a closed rate. They suit someone who:

• Expects to sell soon.
• Is waiting for a large sum, such as an inheritance or the sale of another property.
• Wants to repay quickly.

Between the two: semi-open and convertible

Some lenders offer semi-open or convertible mortgages. A convertible mortgage can be converted to a longer closed term without a penalty, which can be a middle path. Ask about the conversion rate, which is often a posted-based rate.

Example: $400,000 closed mortgage with a 15% annual lump-sum privilege

• You can pay up to $60,000 extra each year without penalty.
• Paying an extra $10,000 in the first year lowers your balance and saves interest on it for the rest of the mortgage.
• Repaying $150,000 in one go in year two would exceed the limit and could mean a penalty.

Questions to ask

• How much can I prepay, and when in the year?
• Can I increase my payment, and by how much?
• What happens if I sell?
• Is the mortgage portable?
• How is the penalty calculated?

How to decide

A closed mortgage with generous prepayment privileges is often the best balance for people who plan to stay a few years and pay extra when they can. Choose an open mortgage only when you know you will use the flexibility, since the higher rate costs more than most people save.