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Open mortgages vs closed mortgages
Open mortgages have no penalties or early payment charges when it comes to lump sum payments or paying out your whole mortgage balance early. Because of this flexibility, the interest rate on open mortgages is usually a variable and higher rate with a shorter mortgage term. Closed mortgages are more common among Canadian homeowners as they generally offer lower interest rates and a longer mortgage term; you can still make extra payments on these mortgages, but they will be limited to either 15% or 20% of the outstanding balance. The lower interest rates of closed mortgages may provide more affordable monthly payments, however, they will included a clause that limits their prepayment privileges each year and/or month and a early payment penalty if more than the permitted amount of mortgage principal is repaid.
Variable mortgage rates vs fixed mortgage rates
Variable mortgage rates are typically lower than fixed-rate mortgages, but, the rates on variable mortgages fluctuate with changing market dynamics – specifically, the Bank of Canada’s Prime Lending Rate. This means your mortgage interest rate may go up or down during the term of your mortgage. While your regular payment will remain constant with a Variable Rate Mortgage (VRM), the change in the interest rate will impact the amount of principal you pay off each month, in other words as interest rates rise you will pay more interest and less principal each month. When rates on variable interest rate mortgages (VRM) decrease, a larger portion of your regular payment is applied to the principal and less towards the interest portion. There is a type of variable rate mortgage called an Adjustable Rate Mortgage (ARM) where the monthly payment does go up or down as the BOC Prime Lending Rate changes maintaining your original amortization schedule.
Rates on fixed mortgages do not change for a pre-determined period of time (the mortgage term), fixed rate mortgage terms are typically offered in 1, 2, 3, 4, 5, 7 or 10 year time frames. The most commonly chosen fixed rate term has traditionally been the 5 Year Fixed Term.
Mortgage Term refers to the length of time the rate you select is guaranteed by the lender. During the mortgage term, the agreed upon parameters will be in force including, the interest rate, prepayment privileges, payment amount and payment frequency. The mortgage terms are typically between 1 to 5 years, 7 and 10 years; 5 years is the most common mortgage term chosen by homeowners in Canada.
The amortization period is the time it will take to pay off the mortgage in full based on the current mortgage interest rate, , loan balance, payment amount and payment frequency. Increasing or decreasing payment amounts or frequency will impact the amortization period. Fluctuations in the mortgage interest rate with a variable rate mortgage (VRM) will also impact the amortization period. If rates increase (which means you are paying less principal and more interest with each regular monthly payment), this may lengthen the amortization period. Conversely, if rates decrease (which means you are paying more principal and less interest with each regular monthly payment), this may shorten the amortization period. The amortization period can range between 5 to 40 years depending on the Bank, Credit Union, Mono-line Mortgage Lender, with 25 years being the most common amortization period chosen by Canadian homeowners.
Mortgage prepayment penalties
Most mortgage loans come with the ability to make extra payments above and beyond your regular mortgage payment, referred to by Lenders as either prepayment privileges. The Lender will set a limit on how much you are permitted to pay in a given year or month. If you pay more than the permitted prepayment privilege amount the Lender will charge you a penalty. Common prepayment privileges are 15% or 20% per year of the outstanding mortgage balance, and 15% to 20% of the regular payment amount. Another example of when a lender will charge a early payment penalty is if you wish to payout or renew/refinance your loan before the mortgage term ends. The penalties and how they are calculated are included in the mortgage contract and should be read and understood before signing the loan document.