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New Purchase Mortgage

Open Mortgage in Canada

Everything you need to know about open mortgages in Canada – how they work, pros and cons, rates, terms, prepayment options, and more.

Are you in the market for a new mortgage in Canada and want to understand all your options? With an unpredictable real estate environment, many homebuyers and homeowners are considering more flexible mortgage options, such as open mortgages.

But how exactly do open mortgages work, and are they the right products for your situation?

Whether you are purchasing your first home, refinancing your current mortgage, or preparing for renewal, this extensive guide will provide you with everything you need to know about open mortgages in Canada for 2024 and help you determine if they are the best choice for you.

What is an Open Mortgage?

An open mortgage is a flexible option that allows borrowers to pay off the mortgage principal at any time without penalties. You can pay lump sums, increase your payment amounts, or even pay off the entire mortgage early with no prepayment charges.

Open mortgages differ from closed mortgages, which charge a penalty fee if you break the mortgage, refinance, or pay off your mortgage before the full term. Closed mortgages allow some prepayment but are usually limited to 10-20% of the mortgage annually.

The interest rate on an open mortgage is typically higher than on a closed mortgage, but the flexibility and lack of penalties provide borrowers with more options.

Key features of Open Mortgages in Canada

  • Shorter terms – Ranging from 6 months to 5 years, while closed mortgages can be up to 10 years.
  • Higher interest rates – Currently averages 1 – 2% higher than closed mortgages from the same lender. [Source]
  • Flexible prepayment – Allow prepaying the principal by lump sum or accelerated payments without prepayment penalties.
  • Freedom to switch lenders – You can transfer to another lender at any time with no penalties. Closed mortgages charge transfer fees.
  • Ability to convert to closed mortgage – Many open mortgages let you convert to a closed mortgage with the same lender if you want to lock in a rate.

Open Mortgages in Canada

Despite providing many advantages to flexible payments, open mortgages are less prevalent in Canada than closed mortgages. Around 70% of Canadians select fixed-rate closed mortgages, primarily for financial stability and lower rates.

(Source: https://www.pine.ca/blog/open-vs-closed-mortgages-in-canada)

Over the past year, open mortgage rates have increased alongside the Bank of Canada’s interest rate hikes. Further increases are expected in 2023-2024.

Open mortgages appeal to first-time home buyers and current homeowners looking to refinance or renew their mortgages. If they foresee needing extra funds soon, more borrowers are considering open mortgages that allow prepayments.

Term Lengths Available for Open Mortgages

Open mortgages are offered in much shorter terms than closed mortgages. Here are the typical terms available:

6 months The shortest term, giving maximum flexibility. Only offered by some lenders.
1 year A short term that allows you to renegotiate your rate annually if rates decline.
2 yearsRarely offered. It may have higher rates than 3 or 5 years.
3 yearsA good compromise between flexibility and reasonable rates.
5 yearsThe most common and longest term. Rates are lowest.
Term Lengths Available

The shorter your term, the more often you’ll have to renew your mortgage, face application costs, and run the risk of higher rates at renewal. But you’ll also benefit if rates fall.

Carefully weigh whether the lower rates on a longer term outweigh the flexibility of a shorter term for your situation.

Advantages and Disadvantages of Open Mortgages in Canada

Before deciding on an open mortgage, it’s important to carefully weigh its pros and cons and consider your short and long-term financial goals.

Advantages and Disadvantages of Open Mortgage
Pros and Cons of Open Mortgage

Advantages of Open Mortgages

Flexibility

The main benefit of an open mortgage is the flexibility it provides. You can:

  • Pay off your mortgage in full at any time with no penalties.
  • Make accelerated payments
  • Make extra lump sum payments on your principal.
  • Refinance your mortgage whenever you want
  • Switch lenders without early payout charges.
  • Convert to a closed mortgage if you want to lock in a rate.

This flexibility enables borrowers to take advantage of financial windfalls, sell their homes, or refinance when rates drop without facing hefty fees. If utilized wisely, this can save thousands in interest costs over time.

Lower Penalties

If you need to break your open mortgage early for any reason, you won’t pay expensive prepayment penalties like a closed mortgage. Closed mortgage penalties can be three months of interest or more.

Shorter Terms

The shorter 1-5 year terms allow you to take advantage of lower rates faster when interest rates drop, without waiting until your term expires. This provides more opportunities to get better rates.

Peace of Mind

Choosing an open mortgage provides peace of mind that you can sell your home, refinance, or make extra payments at any time that suits your financial needs. You aren’t locked in long-term.

For example, John has a $300,000 open mortgage. In August, he received a $60,000 inheritance. Because John has an open mortgage, he could apply the entire $60,000 as a lump sum payment on his principal without any penalties, allowing him to pay off his mortgage much faster.

Disadvantages of Open Mortgages

Higher Interest Rates

The main disadvantage of this type of mortgage is that their interest rates are typically higher than comparable closed mortgage rates from the same lender over a 5-year term, which can add up to thousands in extra interest costs.

Limited Availability

Not all lenders offer open mortgages, and when they do, the terms and options may be more restricted compared to closed mortgages from the same lender.

Less Payment Stability

Because the terms are shorter, you will have to renew your mortgage and apply more often, facing the risk that rates will be higher at each renewal. Closed terms up to 10 years provide more payment stability.

More Discipline Required

The prepayment flexibility of an open mortgage means you need discipline not to accumulate other debts before aggressively paying down your mortgage, or you miss out on the benefits.

Potentially Higher Renewal Rates

If interest rates have risen significantly by the time your short term expires, your payments could rise sharply upon renewal. A longer closed term may provide more protection.

How open mortgages faster your payments?

While rules vary by lender, here are some common prepayment privileges when getting open mortgages:

  • Lump sum payments – Most lenders allow lump sum payments without penalty.
  • Increased payments – You can increase your regular mortgage payments to pay off your mortgage faster.
  • Double-up payments – Some lenders allow you to make an extra monthly payment on top of your regular payment up to a specified limit.
  • Accelerated payments – Switching from monthly to bi-weekly or weekly accelerated payments can help pay off your mortgage years sooner.
  • Pay off mortgage in full – It allows you to pay off your entire mortgage balance without any prepayment penalties.

Always confirm the specific prepayment rules for an open mortgage before committing to avoid surprises. Having prepayment privileges can save you thousands in interest costs over the life of your mortgage.

When Does an Open Mortgage Make Sense?

When Does an Open Mortgage Make Sense?
When Does an Open Mortgage Make Sense?

Given that open mortgages play a niche role compared to more popular closed mortgages in Canada, in what situations does it align well with a borrower’s needs?

  • If You Plan to Sell Soon

Open mortgages allow you to sell your home and pay off the mortgage early without prepayment penalties. This flexibility suits those planning to sell within 1-5 years.

  • Borrowers with Variable or Unpredictable Income

For borrowers with fluctuating incomes, an open mortgage enables making extra lump sum payments when you have surplus funds available.

Consider this example, Mark is self-employed, and his monthly income fluctuates. An open mortgage allows him to make extra lump sum payments when he has a good month.

  • First-time Homebuyers Seeking flexibility

The lower penalty fees and flexible prepayment options may benefit first-time buyers still getting settled financially.

  • Nearing Your Mortgage Renewal Date

Homeowners approaching their mortgage renewal date may want an open mortgage to take advantage of lower rates sooner without a big penalty.

  • Anticipating a Financial Windfall

If you foresee a large financial windfall soon, like an inheritance or bonus payout, an open mortgage gives you the freedom to allocate those funds to pay down your mortgage faster without penalty.

Your mortgage broker or advisor can help you determine whether an open or closed mortgage is better suited to your specific financial situation and goals.

Applying for an Open Mortgage in Canada

Here are some key steps of the application process for getting approved for an open mortgage in Canada

Documentation Required

Like any mortgage, you’ll need to provide:

  • Proof of income and employment
  • Down payment funds and assets
  • Tax documents
  • ID and address verification
  • Credit check consent

Mortgage brokers and lenders will use this to assess your eligibility. Having all documents ready can help speed up the process.

Working With a Mortgage Broker vs. Direct Lender

You can apply for an open mortgage directly through a bank/lender or an independent mortgage broker.

Mortgage brokers can access multiple lenders and help you find the best rate. They also handle the application paperwork for you.

Direct lenders may offer online, or their specialists can assist you. They have access to their mortgage products.

For example, James worked with a mortgage broker to find an open mortgage. The broker compared rates and features from over 10 lenders, negotiated on James’ behalf, and handled all the application details. In contrast, Alex applied directly through his bank’s website in about 15 minutes but was limited to only that lender’s mortgage products.

Therefore, you should consider both routes and interview a few brokers and lenders to find the best mortgage fit.

Pre-Approval and Qualifying Process

Most lenders and brokers offer free pre-approvals or pre-qualifications to confirm the open mortgage amount you qualify for before making a purchase offer.

This pre-approval letter can give you negotiation power when making an offer and demonstrate you are a serious buyer.

All mortgages in Canada require stress testing to qualify based on your debt ratios and ability to pay if rates rise. This applies to both open and closed mortgages.

The mortgage stress test uses a qualifying rate, typically 2% higher than your contract mortgage rate, to assess whether you can repay your mortgage if rates increase in the future.

Closing Costs and Fees for Open Mortgages

It’s essential to factor in the upfront closing costs and ongoing fees over your mortgage term. These may include:

Upfront Closing Costs

  • Appraisal fee – $300 to $500 [Source]
  • Legal fees – $1000+
  • Land transfer taxes
  • Title insurance fee
  • Mortgage broker fee (if applicable)

Ongoing Fees

  • Interest payments
  • Property taxes
  • Home insurance premiums
  • Mortgage default insurance (if high ratio)
  • Early discharge/payout fees

Aim for an open mortgage with lower fees and ask your mortgage broker to explain all the costs. The flexibility of this mortgage type may justify paying slightly higher fees.

Alternatives of an Open Mortgage to Consider

Open mortgages provide unique flexibility compared to closed mortgages. But in some situations, you may want to consider alternative mortgage products or strategies instead:

  • Short-term closed mortgage: A one-year closed term allows you to renegotiate your rate annually while enjoying lower closed mortgage rates.
  • Variable-rate mortgage: The interest rate fluctuates based on the prime rate, but you can lock in or prepay at any time.
  • Home equity line of credit (HELOC): Gives you a revolving credit limit to access extra funds when needed. You repay the interest monthly.
  • Private mortgage: Borrow from a private lender or individual investor for custom mortgage terms and rates if you qualify.
  • Wait for better rates: If you aren’t in a rush, you may opt to keep monitoring rates and lock into a lower closed rate when favorable.

Discuss your goals and options with mortgage brokers and financial advisors to choose the optimal strategy. An open mortgage isn’t necessarily your only flexible choice.

Tips for Finding the Best Open Mortgage

Finding the Best Open Mortgage
Tips for Finding the Best Mortgage

Here are some tips to make sure you get the top product at the lowest rate for your situation:

  • Compare rates: Get rate quotes from at least 3-5 different banks, brokers, and lenders. Rates and features can vary significantly.
  • Ask about prepayment: Don’t just look at the rate. Inquire about each lender’s prepayment privileges, annual lump sum limits, double-up options, and payout fees.
  • Factor in all costs: Consider the total borrowing costs over the full mortgage term, not just the interest rate. Also, account for fees and penalties.
  • Mortgage brokers: An experienced broker can be invaluable in sourcing and negotiating your optimal open mortgage. Consider both brokers and direct lenders.
  • Negotiate – As a well-qualified borrower with a broker, you have more bargaining power. Negotiate the best rate and features.
  • Lock in mortgage rate early: When you find a great rate, lock it in quickly. Open mortgage rates fluctuate often in line with the Bank of Canada’s prime rate.

Read more: Understand Mortgage rate lock in Canada

Conclusion

Open mortgages can give many borrowers the flexibility they need in unpredictable times. But when choosing an open vs. closed mortgage, it’s important to weigh the pros and cons carefully against your short – and long-term financial goals.

Connect with a mortgage expert to discuss your specific situation. Be sure to compare rates and features across multiple lenders to find the top mortgage at the lowest rate for your needs. With discipline and strategic prepayment planning, an open mortgage may enable you to pay off your home faster and save on interest costs.

At Best Mortgage Online, our mortgage experts can help you find the ideal open mortgage product for your unique home financing needs. Contact us today to receive personalized advice and competitive rates, and start leveraging an open mortgage to maximize flexibility and savings!

FAQs

Can I get an open mortgage for a 10-year term in Canada?

No, open mortgage terms max out at 5 years. You need a closed mortgage for longer 10-year terms.

What are the penalties for breaking an open mortgage in Canada early?

Unlike closed mortgages, open mortgages have no prepayment penalties in Canada if you break your term early.

How often do I renew an open mortgage in Canada?

Open mortgages have shorter terms of 6 months to 5 years, so you renew more frequently than a closed mortgage with a longer term

Can I switch between open and closed mortgages in Canada?

Yes, you can switch mortgage types when you renew or refinance, with no penalties for switching from open to closed or vice versa.

Do open mortgages affect your credit score in Canada?

No, having an open mortgage does not directly impact your credit score compared to other mortgage types. Make payments on time.

How do I determine between open or closed mortgage?

Consider your plans to sell, expected income changes, and need for payment stability vs. flexibility when deciding.

What are the risks of open mortgages in Canada?

Risks include higher rates, unpredictable renewals, and the need for discipline to pay off the mortgage before other debts.

Who offers the best open mortgages in Canada?

The top national banks, brokers, credit unions, and private lenders can offer competitive open mortgage rates and features.

What are prepayment options for open mortgages in Canada?

Common options include lump sums, increased payments, double-ups, accelerated frequency, and paying off the full balance.

How do open mortgage rates compare to closed mortgage rates in Canada?

Open mortgage rates from the same lender in Canada typically 1% higher than closed mortgage rates. Always compare both.

Article Sources
  1. Should I choose an open or closed term mortgage? – nbc.ca
  2. The No Commitment Mortgage -truenorthmortgage.ca
  3. What is an open mortgage? – moneysense.ca
  4. Open vs. closed mortgage: What’s the difference? – ratehub.ca

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