What are open vs. closed mortgages in Ontario?

After you’ve made the foundational decision between a fixed and a variable interest rate for your mortgage, you’ll face another crucial choice that will define the very structure of your loan: should you opt for an open or a closed mortgage? This decision pivots on a fundamental trade-off every homebuyer in Ontario must consider: the desire for low borrowing costs versus the need for financial flexibility.

The vast majority of home loans in Canada are closed mortgages, favoured for their attractive interest rates. However, the open mortgage serves a vital, specific purpose for homeowners in transitional periods. Understanding the distinct features, benefits, and drawbacks of each is essential to choosing a mortgage that aligns not just with your budget, but with your life plans as well.

The Closed Mortgage: The Standard for Stability and Savings

A closed mortgage is the default home loan structure in Canada. The “closed” designation refers to the fact that the contract locks you in for a specific mortgage term and includes restrictions on how quickly you can pay it off. It is by no means a financial prison; rather, it’s a structured agreement with clearly defined rules.

Prepayment Privileges

A closed mortgage does not prevent you from paying down your loan faster. Instead, it grants you specific “prepayment privileges,” which are outlined in your mortgage agreement. These typically include:

• Lump-Sum Payments: The ability to pay a lump sum of money against your principal, usually once per year. This is often limited to a certain percentage—commonly 10%, 15%, or 20%—of the original mortgage amount.
• Payment Increases: The option to increase your regular mortgage payment amount by a set percentage, such as 10%, 15%, or 20%, once per year. This extra amount goes directly toward the principal, accelerating your repayment.

The Defining Restriction: Penalty Fees

The “closed” nature becomes most apparent if you try to pay off your mortgage in full before the term is over—for instance, if you sell your home or wish to refinance with another lender. Doing so will trigger substantial mortgage penalty fees. These penalties are the lender’s way of recouping the interest income they expected to earn over the full term.

Why It’s So Popular

Lenders can be confident that a borrower with a closed mortgage will be a customer for the entire term. This security and predictability for the lender is rewarded with much lower interest rates for the borrower. Whether you are looking at a fixed-rate mortgage or a variable-rate mortgage, the most competitive rates will always be found within a closed mortgage structure.

The Open Mortgage: The Champion of Flexibility

An open mortgage is the polar opposite of a closed one. It is designed to offer maximum flexibility with minimal restrictions. With an open mortgage, you have the freedom to pay down as much of your mortgage as you want, at any time, or pay off the entire balance in full without facing any penalty fees whatsoever.

The Ultimate Freedom

This flexibility is invaluable in certain situations. If you need to sell your home unexpectedly, come into a large inheritance, or want to refinance to take advantage of a better offer, an open mortgage allows you to do so without hesitation or financial penalty. You are in complete control.

The High Cost of Freedom

This level of flexibility comes at a steep price. Interest rates on open mortgages are significantly higher than on comparable closed mortgages—often by several percentage points. Lenders charge this substantial premium to compensate themselves for the risk that you might pay back the loan at any moment, thereby cutting off their stream of interest profits. Open mortgages are typically offered with shorter terms, such as 6 months or 1 year, and are almost always a variable-rate product.

Side-by-Side Comparison: Open vs. Closed

When Should You Choose a Closed Mortgage?

A closed mortgage is the most logical and financially sound choice for the vast majority of homebuyers in Ontario. You should choose a closed mortgage if:

• You plan to live in your home for at least the duration of your chosen mortgage term (e.g., you are confident you won’t sell in the next 5 years).
• Your financial situation is relatively stable, and you want to secure the lowest possible interest rate to make your payments as affordable as possible.
• Your goal is to steadily build equity in a home in a cost-effective manner.

When Should You Choose an Open Mortgage?

An open mortgage is a strategic, short-term tool for very specific scenarios. It only makes financial sense if the money you save by avoiding a penalty outweighs the extra interest you’ll pay. Consider an open mortgage if:

• You are anticipating a large cash windfall. If you are absolutely certain you will receive an inheritance, a large work bonus, or proceeds from a business sale that will allow you to pay off the mortgage within a few months to a year.
• You plan to sell the property very soon. If you are flipping a house or if you know you are relocating for work and will need to sell the home in the near future.
• You are in a period of uncertainty. For example, during a marital separation where the home will need to be sold, but the exact timing is unknown.

The choice between an open and closed mortgage is a question of aligning your loan structure with your life’s trajectory. A closed mortgage offers the low rates that make long-term homeownership affordable, asking for commitment in return. An open mortgage provides complete freedom at a premium price, serving as a short-term bridge during times of transition.

For the average Ontario homebuyer, whose goal is to settle in and build a life, the closed mortgage is almost always the right path. It provides the cost-effective foundation for homeownership. But for those in unique, short-term situations, the open mortgage offers a valuable, albeit expensive, tool of financial liberation.