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If you've never had a mortgage before, understanding the nuances of the different types of mortgages available can be very confusing. Choosing the right mortgage can mean the difference of thousands of dollars of interest over the term of your mortgage and more, over the length of amortization. Even seasoned homeowners can be surprised at the costs when they try to break their mortgage or repay it faster than the terms of the mortgage allow. When they apply for their first mortgage, most people only have the end goal of getting into a home with affordable payments and are not thinking about full repayment. However, the type of mortgage you choose, either open or closed, can have an impact on your finances in the future. 

Open Mortgages versus Closed Mortgages

The terms and conditions of all mortgages include rules for how much of the mortgage principal can be paid during the term. Information on what happens if the mortgage is fully discharged before the end of the term is also included. Mortgages that allow you to repay as much of the principal amount as you want, in addition to your regular payments during the term, are called open mortgages. In contrast, a closed mortgage only allows you to pay off a small amount of principal over and above the regular payments—usually no more than about 15%. Open mortgages may also allow you to pay the mortgage amount in full before the end of the term, while a closed mortgage will charge a penalty for breaking the mortgage early. 

This Seems Like a No-Brainer

So why would anyone choose a closed mortgage that does not give you the flexibility to pay the principal down faster? Doing so could save a lot of money in interest over the fifteen to thirty years that it takes most people to pay off their mortgages. One very compelling reason is that closed mortgages tend to offer the lowest interest rates. In order to compensate for the flexibility and potential loss of interest income for the lender, open mortgages have higher interest rates. However, that's not the whole story, and you shouldn't choose your mortgage based on interest rate alone. 

When to Choose Open and When to Choose Closed

First-time homebuyers often have aspirations of paying down more quickly as their incomes rise and their financial situation changes. If you're doing your research, you may have even read that paying down the principal early in the amortization is where the biggest overall savings in interest will occur. That's absolutely true, however, at the time in your life when you are purchasing your first home, most people are also managing other large expenses (think vehicle loans and daycare costs) while also not at the peak of their earning potential. In reality, most homeowners in the first decade of ownership don't have the extra cash to pay off a significant amount of mortgage principal.

Pay Other Higher Interest Debts First

While your mortgage may be the largest single source of debt you have, it is also likely the cheapest. Student loans, vehicle loans, credit card debt and lines of credit often have interest rates that are significantly higher than your mortgage rate. Your financial advisor would tell you to focus on paying those higher-interest debts first, and so would a mortgage broker. 

Your Time May Come for an Open Mortgage

Someday you may find yourself in the financial position to either pay off more than 15% per year of your mortgage principal or to pay off the remaining balance entirely. If you really think that's a possibility, then you should consider an open mortgage the next time you renew. If not, it may serve you better to stick with the lower interest rates of a closed mortgage. Within a closed mortgage, there are still ways to make small repayments that can have an impact over time. 

Accelerated payments allow you to make a nominal overpayment on every mortgage payment. The additional amount goes fully towards reducing the principal. You may have the opportunity to double up payments throughout the year. So in a month where you find you have a little extra cash, you can use that opportunity to shave a little more off the principal. If you're fortunate enough to get a year-end bonus, an investment windfall or some other sum on money, you can leverage the option to make a larger payment towards your principal within the limits of your closed mortgage terms.

Whether you are looking for your first home or it's time to renew your mortgage, talk to a mortgage broker to get honest and professional advice on the type of mortgage that best fits your financial needs. There are no cookie-cutter solutions for the largest personal investment loan you'll ever take on. Dave Destefano can explain the pros and cons of the various types of mortgage products and help find the one that best meets your needs. Give Dave a call today!