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What is a Variable Closed Mortgage in Canada?

A variable closed mortgage in Canada combines the benefits of a variable interest rate with the structure of a closed mortgage. The interest rate in this mortgage type fluctuates based on changes to the lender’s prime rate, which is influenced by the Bank of Canada’s interest rate.

However, as a closed mortgage, it comes with restrictions on prepayments or early termination without incurring penalties.

This type of mortgage is appealing to borrowers looking for the potential savings of lower interest rates compared to fixed-rate mortgages, while still benefiting from the typically reduced rates associated with closed mortgages.

Borrowers commit to a set mortgage term, but payments may vary over time depending on the interest rate changes. While the principal and interest allocation might adjust, monthly payments often remain predictable.

Benefits of Variable Closed Mortgages

The benefits of variable closed mortgage are:

Lower Initial Interest Rates

Variable rates are typically lower than fixed rates, offering potential for significant savings over the mortgage term.

Rate Adjustment Opportunities

If interest rates decrease, borrowers may benefit from reduced mortgage payments.

Long-Term Stability

Offers predictable monthly payments due to fixed terms, even with fluctuating interest rates.

Potential for Conversion

Some lenders allow borrowers to convert to a fixed-rate mortgage if financial circumstances or the housing market change.

Prepayment Privileges

Many lenders offer prepayment flexibility, allowing lump-sum payments up to a certain percentage without penalties.

A variable closed mortgage is ideal for borrowers seeking lower costs while balancing some flexibility for repayment within the confines of a closed mortgage.

What is a Variable Open Mortgage?

A variable open mortgage offers borrowers the flexibility of an open mortgage combined with the potential cost savings of a variable interest rate. In this arrangement, the interest rate fluctuates based on the lender’s prime rate, which is linked to changes in the Bank of Canada’s interest rate.

Unlike a variable closed mortgage, borrowers can make lump-sum payments, increase monthly payments, or even pay off the entire mortgage balance at any time without incurring prepayment penalties.

Variable open mortgages are an excellent choice for borrowers who anticipate financial windfalls, plan to sell their home, or prefer the freedom to adjust their payments without restrictions. However, they typically come with higher interest rates compared to closed mortgages, reflecting the added flexibility.

Benefits of Variable Open Mortgages

No Prepayment Penalties

Allows borrowers to pay off the mortgage or make additional payments without incurring extra costs.

Flexibility

Ideal for short-term borrowing needs or for those planning to refinance or sell their property in the near future.

Potential Savings

If interest rates decrease, borrowers can benefit from lower costs due to the variable rate structure.

Freedom to Adjust Payments

Borrowers can increase payments or reduce the mortgage balance more quickly.

Shortened Amortization Period

Offers the ability to save on interest and shorten the repayment timeline with additional payments.

A variable open mortgage is a suitable option for borrowers seeking ultimate prepayment flexibility and control over their mortgage.

Variable Open vs Variable Closed Mortgage

Choosing between a variable open mortgage and a variable closed mortgage depends on your financial goals, level of flexibility, and tolerance for interest rate fluctuations. Both mortgage types offer variable interest rates, meaning the rates change with the lender’s prime rate, but they differ significantly in terms of payment flexibility, penalties, and cost.

Key Differences between Open and Closed Mortgages

The key differences between open and closed mortgages include:

Flexibility

A variable open mortgage offers maximum prepayment flexibility, allowing borrowers to make lump-sum payments, increase monthly payments, or pay off the mortgage entirely at any time without penalties.

A variable closed mortgage comes with restrictions, as it is designed for borrowers who commit to a fixed mortgage term. Breaking the mortgage early or making additional payments beyond the prepayment privileges usually incurs prepayment penalties.

Interest Rates

Variable open mortgages generally have higher interest rates than variable closed mortgages due to the added flexibility they provide.

Variable closed mortgages offer lower interest rates, making them a cost-effective choice for borrowers planning to stay within the terms of the mortgage.

Cost Implications

With a variable open mortgage, borrowers can save on interest costs if they make additional payments or take advantage of decreasing rates.

Variable closed mortgages are more suited for those who prioritize long-term stability and predictable monthly payments, even with interest rate adjustments.

Variable Open vs. Closed Mortgages: Which is Right for You?

Deciding between a variable open and closed mortgage comes down to your financial goals, lifestyle, and tolerance for flexibility versus cost. Each option has its unique advantages, catering to different borrower needs.

A variable open mortgage is best suited for borrowers who value freedom and flexibility. If you anticipate a financial windfall, plan to sell your home, or might want to refinance in the near future, the open mortgage allows you to make lump-sum payments, increase your monthly payments, or pay off the balance entirely without incurring prepayment penalties.

However, this flexibility comes at a cost—variable open mortgages typically have higher interest rates, which may increase your monthly expenses.

On the other hand, a variable closed mortgage is an excellent option for those looking for lower interest rates and a structured repayment plan.

While this type of mortgages restrict your ability to make significant prepayments without penalties, they offer cost savings for borrowers who plan to stay in their homes for the duration of the mortgage term. Some lenders even offer prepayment privileges, allowing limited additional payments without penalty.

Ultimately, your decision should depend on your financial situation, future plans, and whether stability or flexibility better aligns with your needs. Evaluating your personal circumstances carefully will help you choose the right option.

Making the Right Choice: Open vs. Closed Mortgages in Real-Life Scenarios

Choosing between open and closed mortgages involves weighing flexibility against cost. Each mortgage type suits different financial needs and life situations, and understanding their implications is key to making the right decision.

Breaking Down the Costs

For borrowers considering paying off their mortgage early, understanding the cost implications is crucial. Closed mortgages tend to have lower interest rates, making them attractive for Canadian homeowners focused on regular payments and long-term stability. However, breaking a closed mortgage contract often incurs a prepayment penalty, calculated as the interest rate differential (IRD) or a percentage of the mortgage balance. This penalty can significantly impact homeowners who need to refinance or sell their property during the mortgage term.

Conversely, variable rate open mortgages allow homeowners to repay their loan without penalties. This flexibility is ideal for short-term borrowers or those expecting a financial windfall, like an inheritance or bonus, that allows them to pay off their mortgage early.

Flexibility vs. Cost

  • Closed Mortgages Tend to lock borrowers into fixed terms but offer some prepayment privileges, such as lump sum payments up to a certain percentage annually. These mortgages are well-suited for those seeking the best mortgage rates and stable monthly payments.
  • Open Mortgages provide unmatched flexibility but come with higher mortgage rates. They are optimal in a few situations, such as when borrowers plan to refinance or sell their home in the short term.

Long-Term Considerations

If you prioritize flexibility, an open mortgage product may make more financial sense. However, for stability and predictability, a closed fixed rate mortgage or closed variable rate mortgage may align better with your financial goals. Carefully assess your future plans, including whether you’ll need to refinance, sell, or make significant prepayments, to select the most appropriate mortgage for your needs.