An open mortgage refers to a loan secured by property in which a borrower with enough funds can fully repay the lender without penalty before it reaches maturity.
As a borrower makes regular repayments towards a home loan, the outstanding balance gradually decreases over time.
When a borrower has accumulated enough money, maybe via a windfall, he might choose to fully repay the debt so as to save on interest charges. However, penalties imposed by lenders such as redemption fees can often deter homeowners from paying off their loans in view of the extra expenses they would have to pay the lenders for full repayment.
Having to pay for these expenses can often be painful enough for borrowers to continue paying a manageable monthly payment instead of having to pay for redemption penalties that they might feel is unfair.
Open mortgages allow borrowers to settle their debt by repaying the full amount of outstanding principal and other interest charges due at any time without having to let the prospect of penalties affect their decision making processes.
It also encourages people to pay off their loans and be debt free instead of having to pay for recurring debt obligations.
Interest charges that are saved, and the monthly debt obligation that is eliminated, can significantly improve the cash flow of homeowners going forward.
In this sense, it is also possible for a home loan to commence without being “open” and later revert to an open status.
This can occur when there is a lock-in period inserted into the loan contract that stipulates a redemption penalty should a borrower repay the loan within the stated time period.
This is a way for lenders to receive at least a certain amount of interest revenue after having offered very attractive interest rates in order to acquire the customer.
This lock-in mechanism is often a major reason that influences borrowers in refinancing decisions as such activities would mean the repayment of an existing loan.
When the lock-in period expires, it no longer has a prepayment penalty and thus becomes an open mortgage.
The loan can then be repaid without penalties.
More and more housing loans are conceptualized to be open mortgages from the start. However, lenders can indirectly attach penalties such as clawbacks of subsidies that has been granted to borrowers when the client was first acquired.
So while they are technically open, they are not necessarily so.
A homeowner with an open mortgage would also be able to better consider getting an extra loan on top of the existing home loan, maybe via a home equity loan.
This is because there are no penalties involved.
Homeowners should however note that this can have tax implications.
Alternative meanings to open mortgage
The term open mortgage can also be found as an open mortgage clause found in insurance policies.
This clause, when triggered, ensures that a lender is paid for the balance amount owed on the mortgage.
Open mortgage can also refer a secured loan that has matured or open to foreclosure proceedings due to it being overdue.
