Closed Mortgage

A closed mortgage is a financial concept that restricts the possible financial steps that can be taken by a person for a specified time period during the term of a mortgage. Closed mortgages particularly find favor with many banks as this device has an inherent element of certainty for the bank in terms of returns. The mortgage taker must commit for a specific span of time, normally three or five years, to a closing of the mortgage, while the banks have the assurance that this amount of money is available out in the market for that time of commitment. This works well for the banks as it becomes possible for them to calculate down to the last penny, their likely profits on the loan, because they know exactly what it was that they paid for the money and the amount of payment due to them in return. Closed mortgages are usually made available by banks with a lower interest rate for these reasons.

A close mortgage can be said to be a mortgage for which no prepayment of principal is required during the term.

In finance, there is significant confusion with regard to the ability of a mortgagor's to make prepayments on a mortgage he or she has agreed on. In fundamental terms, the signing of a mortgage document, essentially means that a person has entered into a contract with the mortgagee - mostly banks. Such agreements usually run for a specified amount of time and this time limit cannot be changed unless the mortgage terms or related documentation have provisions to this effect. As per the contract, the mortgagor has essentially agreed to make continuous payments based on the specified schedule running to the stated period covered by the contract. It may happen that the mortgager or borrower may like to make changes during the term that such contracts are in operation. In such instances, the mortgagor who decides to give extra payments, or completely discharge the loan before the term has ended can be regarded as seeking an amendment to the original terms of the contract. Such amendments need to be carried out by mutual consent and cannot be carried out alone by one of the parties to the contract. In such instances, the mortgagee can refuse to give consent to the making of the amendment and is also entitled to demand costs from the mortgager for giving such consent in case it accepts the making of such amendments.

The closed period of a mortgage has been specifically defined under the Interest Act, a federal statute, this act is very specific about the closed period. Under this act, the absence of a prepayment privilege explicitly written in the mortgage document agreed to means that the borrower may prepay a conventional closed mortgage loan owed to the lender only if certain specified situations are fulfilled or met.

The act provides that amendments for prepayments may be carried out with special permission of the mortgagee and an amendment must be subject to conditions given by the mortgagee. Legally, a loan given to any individual can be repaid after five years; this is subject to the payment of three months of interest penalty - a bonus. On the other hand, a loan given to a corporate borrower may be prepaid only if the lender agrees.

Prepayments by the borrower can usually be done if it is an open mortgage, such payments may be made at any time in any amount during the term of the contract and in some cases, and such prepayments may attract a penalty. In addition, all open mortgages have traditionally come with high interest rates.

It is important to remember that only the term of the mortgage is open or closed, though consumers have the tendency to use the phrase open mortgage or closed mortgage when speaking of mortgages. When speaking of a closed term of a mortgage, it means that the mortgage may not be paid completely or in partial amounts before the term of the mortgage has expired. A closed term of a mortgage with respect to the lender means that the mortgagor agrees to borrow the money from the lender for a specified time period at an agreed interest rate - which cannot be normally changed during that time period. If the borrower seeks to repay the loan amount before it is due, it means that the contract needs to be broken. In such a case, all the interest owed to the lender till the expiry of the term must be paid by the borrower along with the prepayment of the loan.

In an open mortgage, the borrower may make a prepayment of the principal amount, though, the amount that can be prepaid and the terms of prepayment can be varied. In some instances, the mortgage taken is called fully open - that is payments of the amount owed are allowed. In other cases, the mortgage is partially open, with prepayments only allowed at specified times and in specified permitted amounts. It is important to have a clear picture about the issue of prepayment privileges and the penalties associated with such prepayments. At present, the majority of lenders in the market normally charge three months interest or an interest differential, if the current rate is higher, whichever is greater. The major lenders usually calculate the payout penalties as simple interest; this is the general rule though different lenders may act differently. A simple interest calculation works out to be greater than the compounded amount because of the short time period involved, normally three months - thus the lender stands to gain in this calculation.

In the open market, borrowers will come across a range of prepayment options, some will come with penalties and some will be without penalties. In addition, the provincial legislation may lay down specific requirements for any given region.

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