Open Or Closed Mortgage

Before we delve into the issue of benefits of the open and closed mortgages, it is essential to know what these two types of mortgages denote. An open mortgage is one where a loan is secured against a property and can be repaid any time before its amortization of maturity without having to pay any fine. In fact, compared to ordinary mortgages, open mortgages are available at relatively higher interest fees. On the other hand, a closed mortgage is one where the debtor does not have the option to repay the loan before its maturity period.

When a borrower obtains an open mortgage he or she can augment the repayments towards the principal amount borrowed any time they wish to do so. In fact, this can be done by increasing the monthly repayment amounts as this would not affect the borrower's lifestyle or budget. As mentioned earlier, an open mortgage offers the borrower the option to clear the debt any time before the expiry of its term or the amortization period. As open mortgages are very flexible and do not involve payment of any penalty if cleared in due time, they actually cost the borrowers more compared to the ordinary closed mortgages. In the case of open mortgages, the borrower usually has to pay 0.5 per cent to 1.0 per cent more as interest fees.

Contrarily, a closed mortgage prevents the borrower from repaying the loan secured against any property before the maturity date or the term of the mortgage. Unless, the original mortgage payment includes a clause regarding advance repayment of the loan, the borrower will actually have to pay a fine if he or she makes any payment in advance towards clearing the credit. In the event of repaying the loan in full before its maturity date, the borrower will be required to pay a penalty equivalent to three months' interest. In such circumstances, the borrower may alternatively be required to pay an interest rate differential (IRD) depending on which is more. For instance, if a borrower has obtained a mortgage at 10 per cent annual interest rate that still has two years to mature and the current market interest fee on a mortgage for two years is 6.0 per cent, the mortgagee would actually be losing 4.0 per cent of interest on the balance amount if the borrowed repaid the entire closed-term mortgage two years before the maturity period mentioned in the original mortgage contract. In this situation, the lender will work out the interest loss to him or her for the period and charge this as a penalty from the borrower. On the other hand, if the prevailing interest rates in the market had soared from 10 per cent to 14 per cent, the lender will actually make a profit if the borrower paid the entire closed-end mortgage two years before the maturity date. In such a situation, the lender will be able to lend out the amount to a new mortgagor at a higher interest rate (14 per cent) and still charge a penalty equivalent to three months' interest from the borrower.

Hence, it is advisable that the borrowers must cautiously go through every minute detail of the mortgage contract. This is important as the mortgage terms differ extensively and mortgagees everywhere do not use the same method to work out the interest rate differential (IRD). For instance, if a borrower has a closed mortgage that is scheduled to mature in five years and is already in the fourth year of the mortgage, many mortgagees will charge a penalty on the basis of the prevailing interest rate for a five-year mortgage and not on the remaining period of one year. While this will immensely benefit the lender, there are many other mortgagees who calculate the penalty on the basis of the remaining period of the mortgage term. However, in the event of a person purchasing the property secured against the credit and enters into a new mortgage agreement with the same lender, the creditor will not claim any penalty from the first borrower. The penalty will also be waived if the buyer of the property agrees to carry with the mortgage secured by the original property owner.

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