Key Takeaways
- A closed-end mortgage provides a lump sum that must be repaid by a set date with fixed monthly payments.
- This mortgage type doesn’t allow principal increases or access to paid-down funds.
- Closed-end mortgages typically have lower interest rates than open-end mortgages, offering cost savings.
- They are suitable for borrowers who prefer predictable payment schedules and terms.
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What Is a Closed-End Mortgage?
A closed-end mortgage, also known as a “closed mortgage,” is a common type of mortgage in which the lender provides you with a lump sum of financing. You then repay the mortgage by a certain date in monthly installments that include interest and principal. Unlike open-end mortgages, you cannot extend the amount of the principal or reuse it as you pay down the loan. Closed-end mortgages may include prepayment penalties.
Learn more about how closed-end mortgages work and how they compare to open-end mortgages. Weigh the pros and cons and determine which is best for you.
How Closed-End Mortgages Work
A closed-end mortgage is a common type of mortgage used by many homeowners. It can have a fixed or variable interest rate or different term lengths, such as 30 years or 15 years. You receive the funding in a lump sum, then you repay it during the set term in regular payments.
Unlike with an open-end mortgage, as you repay the mortgage, you cannot reuse the credit. Essentially, closed-end mortgages are one-time loans, not revolving lines of credit.
When you take out a closed-end mortgage, your home will be used as collateral that backs the mortgage. This lower the risk for the lender because they can then take your home to resell if you fail to make payments according to the terms. Closed-end mortgages also prohibit pledging collateral that has already been pledged to another party.
Important
Depending on the terms of a closed-end mortgage, you may face a prepayment penalty if you pay off your mortgage in full too soon.
Many lenders do not impose a prepayment penalty on closed-end mortgages, but be sure to fully understand what your lender or potential lender requires. In some cases, you may be able to make smaller payments toward your principal up to a limit. In other cases, you may have to wait several years before you can pay off your mortgage early without penalty.
Comparing Open-End and Closed-End Mortgages
Closed-end mortgages haves several similarities and differences with open-end mortgages. Both types of mortgages provide financing that uses your home as collateral.
However, with closed-end mortgages you borrow the lump sum but cannot use the credit again once you have repaid it. With open-end mortgages, you use the initial lump sum to purchase the home. Then, as you repay the loan, you can borrow funds again. A secondary mortgage that offers revolving credit using your home equity as collateral, like a home equity line of credit (HELOC), is also a type of open-end mortgage.
You can get closed-end mortgages with a fixed rate, which remains the same through the mortgage term and results in predictable monthly payments, or a variable rate, which changes along with broader market changes. Open-end mortgages generally have an variable rate. Interest rates on closed-end and open-end mortgages will vary depending on the broader interest rate environment, although rates on closed-end mortgages are typically lower.
With both closed-end and open-end mortgages, the mortgage lender will determine whether to approve you for the loan based on factors like your debt level, income, credit score, and other financial information.
Note
Convertible ARM mortgages, which allow you to convert your adjustable-rate mortgage to a fixed-rate one after a set time period, are a type of closed-end mortgage.
Advantages and Disadvantages of Closed-End Mortgages
The primary advantage of a closed-end mortgage that, with fixed-rate loans, they can offer predictability and may have lower interest rates. Closed-end mortgages can be a good choice if you are taking out a primary mortgage to buy a home and you plan to stay in your home for a long time.
The disadvantage of a closed-end mortgage is that it may include a prepayment penalty in which you pay a fee if you pay your mortgage down early. You will also not get the benefit of being able to reuse your funds once you pay down your loan.
Similarly, open-end mortgages can be better for people who anticipate needing to reuse their credit after they have paid down their mortgage, or a portion of it. For example, you may have significant credit card debt that you could use money from an open-end mortgage to pay off at a lower interest rate.
How Do You Qualify for an Open-End Mortgage?
Like with a closed-end mortgage, the criteria for qualifying for an open-end mortgage will vary from lender to lender. An underwriter will consider factors like your income, debt level, credit score, and net worth, among other financial metrics when deciding whether to approve you for a loan.
Do All Mortgages Have a Pre-Payment Penalty?
Some mortgages have a pre-payment penalty, but not all do. In many cases, you can put at least a small amount toward your principal without paying a pre-payment penalty. In some cases, you may be required to hold the mortgage for a set number of years before you can pay it off early without a fee.
Is Interest Rate on an Open Rate Mortgage Lower?
In general, interest rates are higher on open-ended mortgages compared to closed-end mortgages. To get the best interest rate, shop around and compare different mortgages’ terms and fees, including pre-payment penalties.
The Bottom Line
Closed-end mortgages are common mortgages, but the terms can vary from lender to lender. It’s important to read the fine print so you fully understand what pre-payment penalties you may face if you pay down the loan early. Ultimately, the right type of mortgage for you will depend on your priorities and financial situation.