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What is a Closed Term Mortgage?

March 27, 2015 | Posted by Nathan Zacharias | Tagged in

A closed term mortgage is a more restricted form of a mortgage agreement. Closed mortgages are constructed to either prevent the mortgage recipient from repaying the mortgage in full during the term of the loan, limit the ability to repay the loan in full, or allow repayment with a penalty for breaking the contract.

 Mortgage Agreement

Although the recipient can pay down the loan within the mortgage term by making regular principal and interest payments, limited lump sum payments usually from 10% to 15% of the original mortgage principal, they will generally face prepayment penalties by exceeding this pre-established benchmark or by paying it off in full.

These penalties are implemented to compensate the lender for the interest they will not receive for the remainder of the mortgage term. Some closed mortgages do allow limited prepayments throughout the year and the penalties normally only affect borrowers who are intending to pay off significant proportions of their mortgage, or those who need to sell their home and pay out the mortgage in full. However, a truly closed mortgage will not allow prepayment in full without paying the interest on the entire mortgage term.

In short, a closed term mortgage places restrictions – financial penalties – around the borrower making a large lump-sum payment or refinancing of their mortgage before its contracted term is up.

Reasons to get a closed term mortgage
A closed term mortgage can be highly advantageous to the right kind of borrower. This is because a closed term mortgage will normally have a much lower mortgage rate than open term mortgages.

Because of the deeply discounted mortgage rates, a closed term mortgage can be a good choice if the recipient has no intention of selling the home within their mortgage term, making mortgage prepayments greater than what are allowed, refinancing or taking equity from the home before the end of the mortgage term.

Reasons against a closed term mortgage
The main deterrent against closed term mortgages is that they greatly reduce the borrower’s flexibility.

This means that making major payments against the mortgage’s principal – payments which will reduce monthly interest payments over the remainder of the mortgage’s term – are not allowed in excess.

It’s not hard to think of a scenario where a borrower comes into a large amount of windfall money – selling a car, a company bonus, or receiving a substantial inheritance – and will want to use this cash against their biggest debt obligation: the mortgage. If these are concerns for you, consider an open term mortgage, which offers more flexible prepayment options without the risk of financial penalty.

Many people in today’s low interest rate environment would rather invest their money elsewhere than pay down mortgage debt that is extended at rates of 3% or less. For this reason, closed mortgages have been increasingly popular, as people who have money to spend are using it elsewhere instead of paying down their mortgage.

If you’re unsure of what kind of mortgage would benefit you best, talk to the experts and see what options you have available.