What is a Closed-end Mortgage?
A closed-end mortgage, also known as a closed mortgage, is a form of loan that can’t be prepaid, renegotiated, or refinanced without the lender charging breakage fees or other penalties.
This form of loan is appropriate for homeowners who do not expect to move very soon and are willing to commit for a longer period of time in return for a reduced interest rate. Closed-end mortgages also prevent you from pledging collateral that has previously been committed to someone else.
Closed-end Mortgage Definition
A mortgage loan that has been fully financed at the time of closing. In contrast, an open-end mortgage allows the principal balance to grow over time. A house loan is usually a closed-end loan, whereas a construction loan is usually an open-end loan.
How does a Closed-end Mortgage work?
A closed-end mortgage might have a fixed or variable interest rate, but the borrower is subject to a number of limitations.
Closed-end mortgages, for example, prevent borrowers from utilizing the equity they’ve established in their property as security for subsequent loans. So, if a borrower is 15 years into a 30-year, closed-end mortgage and has returned half of their debt, they are unable to obtain a home equity loan or other kind of financing without first obtaining permission from the original lender and paying a breaking fee. In addition, if a closed-end mortgage borrower pays down their principle early, they will be charged a prepayment penalty.
When offering finance to a borrower, lenders may offer closed-end mortgages as a strategy to reduce risk. By having a closed-end mortgage, the lender may be confident that no other lenders can claim the property as collateral if the borrower defaults on the mortgage or declares bankruptcy. In exchange, the closed-end mortgage lender may arrange the deal to provide the borrower with cheaper interest rates.
What should I know about a Closed-end Mortgage?
Homebuyers choosing a closed-end mortgage should read the terms carefully and comprehend the full scope of the requirements. While reduced mortgage interest rates may be appealing, consumers may be constrained in how they manage their finances as a result. A borrower who wishes to pay off their loan early to save money on interest costs, for example, may be charged a penalty or will be left paying the continuous interest for the life of the loan.
What are Advantages and Disadvantages to a Closed-end Mortgage?
A closed-end mortgage has a reduced interest rate as its principal benefit. On closed-end mortgages, lenders will often offer their lowest interest rates, and consumers may be certain that this rate will not alter for the length of the loan.
Closed-end mortgages are a good choice if you want to keep your mortgage for a long time and don’t mind paying it back slowly and steadily—or if you just want the reassurance of knowing that your mortgage payments will remain the same for the duration of your loan.
The negative of a closed-end mortgage is that it restricts your options. If you inherit a large quantity of money and have a closed-end mortgage, you won’t be able to use the funds to pay off the loan more quickly.
Similarly, open-end mortgages may be preferable for those whose careers are still in their early stages, as they may adapt their repayments to their income rather than a fixed amount. As a result, open-end mortgages can assist you in paying off your mortgage more quickly, but at a higher interest rate.
If you have any other questions regarding Closed-end Mortgages, contact the mortgage experts at Mortgage Rates Today!
Last Updated on 05/25/2022 by Mark Verhoeven
Financial Consultant and Author