Open vs. closed mortgages: what's the difference?

The one you choose determines whether you can make increased or additional prepayments or pay off your mortgage early. However, there are financial penalties if you break the terms of your contract. 

But before you commit to one or the other, there are a few important things to know about the difference between open and closed mortgages. 

Read more: Is refinancing your mortgage worth the interest hit right now? 

Open vs. closed mortgage   

An open mortgage allows for the entire mortgage balance to be paid off in part or in full at any time. In comparison, closed mortgages have more restrictions and limited flexibility for borrowers: You can’t pay off the loan early, refinance or renegotiate the terms without incurring a penalty. 

What makes an open mortgage so appealing is because you can pay it off early or convert it to another term without a prepayment charge. However, closed mortgages are the more popular choice in Canada because they tend to come with lower interest rates, and most people don’t plan to pay off their mortgage in the short term anyway. Closed mortgage terms vary in length from six months to 10 years. 

Related: What is a conventional mortgage? 

What are the pros and cons of open and closed mortgages?  

What are the closed mortgage prepayment penalties?  

A prepayment penalty, also known as break fees, is a fee you’ll have to pay if you break your mortgage contract, transfer your mortgage to another lender before the end of term or you end up paying more than the allowed additional amount towards your mortgage. 

The prepayment penalty only applies to closed mortgages as people with open mortgages can make a prepayment or a lump-sum payment without paying a penalty. 

The prepayment penalty also depends on whether your interest rate is fixed or variable.  

For a variable-rate mortgage, the penalty is usually three months of interest. For a fixed-rate mortgage, the break fee is either three months of interest or the interest rate differential (IRD), whichever is greater. 

Choosing to break a mortgage and pay the penalty will depend on your personal situation. For instance, suppose you have two years remaining on your five-year fixed rate term. However, after comparing rates, you find that you may be able to qualify with another lender at a substantially lower rate.  

Given the uncertainty of future rates, switching now could save you money in the long run. 

Or, if you have a variable rate mortgage and you are concerned about future rate increases, you might choose to switch to a fixed rate mortgage. Locking in the new low rate provides stability and protects against potential rate increases. 

Learn more: What is a hybrid mortgage, and does it ever make sense to get one? 

It’s also important to go over your mortgage contract to find out exactly how your mortgage lender calculates IRD, because there are a few different ways to do it. 

The standard IRD calculation uses the difference between two interest rates: the annual interest rate in your mortgage contract, and the lender’s posted rate closest in duration to the remainder of your term.   

Other lenders use the discounted IRD calculation, which uses the difference between the annual interest rate in your mortgage contract and the lender’s posted rate closest in duration to the remainder of your term, less any discount you received on your initial rate. 

These calculations can be confusing, and lenders have their own ways of calculating IRD using different interest rates. It’s best to talk to a mortgage broker about your options and clarify exactly how the IRD for your particular mortgage contract is calculated. 

Should I go with an open or closed mortgage? 

You might choose an open mortgage if you plan to move within the next year or two, or if you anticipate being able to make additional payments toward your mortgage because you receive extra money from a family inheritance, a bonus or increase in income at work, or the sale of another property. 

A closed mortgage, on the other hand, may be the right choice if you want to stick to a predictable payment schedule and don’t think your personal circumstances will change during the period of your mortgage term. 

All that said, it's not just about getting the lowest interest rate — there are several variables at play when you get a mortgage. Get a quote for your personal situation and talk to a mortgage broker. 

Read next: Want to switch lenders at renewal? Here's what you need to know