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 in by a certain date in monthly payments 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.
Learn more about how closed-end mortgages work and how they compare to open-end mortgage. Then, you can weigh the pros and cons and determine which is best for you.Key Takeaways
- A closed-end mortgage provides a lump sum of financing that you pay down over time and cannot reuse again.
- Close-end mortgages may include prepayment penalties.
- In some cases, you can pay a limited amount of extra money toward the principal, but not a large amount, without paying a penalty.
- Closed-end mortgages are typically less risky for lenders.
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.
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.
Open-End vs. 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.
Pros and Cons of a Closed-End Mortgage
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.