An open-end mortgage is a unique mortgage that gives extends additional flexibility to the borrower. It’s a mortgage product that is important to understand if you are considering getting one. It has unique features similar to that of a revolving credit line and can provide additional funding for borrowers.
- An open-end mortgage allows borrowers to get additional funding from a lender up to their approved loan limit
- Interest only accrues on the amount borrowed
- The draw period is limited to the terms stated in the loan contract
What is an Open-End Mortgage?
An open-end mortgage gives borrowers the option to increase the principal they borrow at a date in the future. It gives borrowers the ability to get additional funding from the lender up to their initial approved limit. When you originally get pre-approved for a loan you may get pre-approved for more than what the home costs. The lender will typically provide you with maximum loan amount you are qualified for.
For example, let’s assume the lender pre-approves you for a maximum of $300,000. The home you are planning to buy only costs $250,000. This leaves you with an additional $50k to borrow later if you happen to get an open-end mortgage.
How Does an Open-End Mortgage Work?
An open-end mortgage functions like a regular mortgage combined with a HELOC. The loan is secured against the property and allows the borrower to pay for the property and borrow additional funds down the road if they so choose. This type of loan is also commonly referred to as a “mortgage for future advances”. The borrower will have to go through the standard underwriting procedure to determine exactly how much they qualify for. Just like a HELOC, borrowers can draw from the available credit, pay it off, and draw again in the future.
Once they know the maximum principal amount they qualify for they have the option of borrowing those funds for a specified period of time. Borrowers can use the portion of the loan value they’re approved for to cover the costs of their home. By taking only a portion of the loan to cover the cost of the home, borrowers are only obligated to make payments on the outstanding balance and not the full amount they are approved for. This is a key advantage to open-end mortgages that makes them such a unique product.
Borrowers can receive the loan principal at any time during the terms of the loan. Depending on the type of open-end mortgage the lender provides, the amount available to borrow may or may not be tied to the underlying value of the home.
Important Note: The additional proceeds received from the open-end mortgage must be used to make improvements or changes to the home.
What Happens When You Tap Into the Additional Credit In An Open-End Mortgage?
The great part of an open-end mortgage is that even though you can access the additional funds later, there is only one lienholder. You will only have a single loan and not two separate ones when compared to getting a HELOC. If you decide to draw the additional available credit, two things can happen:
- The mortgage term gets extended
- The monthly payment increases
The most common thing that tends to happen with an open-end mortgage is that the monthly payment will increase if additional funds are requested. These options will depend on the original terms set within your open-end mortgage.
Important Note: The requirements and options for your open-end mortgage will vary based on the lender you use and also the state in which you live.
Difference Between A Closed-End and Open-End Mortgage?
A closed-end mortgage is simply a traditional mortgage in which you receive all the funds of the loan towards the purchase of the house and have regular fixed monthly payments. On the flip side, you can think of an open-end mortgage as a credit line with your lender. The major difference between a closed-end mortgage and an open-end mortgage is how and when you use the funds.
As previously described, the funds from an open-end mortgage can be tapped into at a future date. The use of funds is also limited and can only be used to make changes or improvements to the home. With a closed-end mortgage, all the funds are used at once to purchase the home and no further funds are available.
Advantages of an Open-End Mortgage
- Interest accrues only on the borrowed amount
- Provides additional financing without an additional lienholder
- No extra origination fees are incurred when using the line of credit
- The credit line can be paid off, used again and paid off again
Disadvantages of an Open-End Mortgage
- Funds can only be used to make changes or improvements to the home
- Draw period is limited to the time stated in the loan contract
- Not offered by all lenders
- Interest rates by may higher depending on the lender
Popular Open-Ended Mortgage Alternatives
There are unique alternatives to open-ended mortgages available to borrowers who don’t like some of their limitations. Below are some alternatives to open-ended mortgages that can offer borrowers more flexibility with the use of the funds.
- Home equity loan
As you can see, an open-ended mortgage can be a great option for borrowers who want funds above the purchase price of their home. The funds can help borrowers make changes and repairs to the house without getting an additional mortgage. However, it’s important to be aware that borrowers are limited to using the additional credit from an open-ended mortgage only towards the house.
Is an Open-Ended Mortgage the Same as a Line of Credit?
Although an open-end mortgage has a similar structure to a line of credit, it’s not the same. The available credit from an open-end mortgage has to be used to purchase a home and make changes and improvements to it. Whereas the funds from a traditional line of credit can be used as needed by the borrower.
What Happens Once You Pay Off an Open-End Mortgage?
An important thing to understand with an open-end mortgage is that it will stay open even after you have paid off your mortgage balance. As such, once you pay off your mortgage balance, you need to request that the lender close the account unless you still want to have access to the credit line.
Do Open-End Mortgages Have Higher Fees?
This will vary from lender to lender, however, the interest rates on open-end mortgages can be higher than traditional mortgages since they are not offered by every lender. Lenders who do offer them may charge slightly higher interest rates to accommodate for the appropriate level of risk.
Can You Refinance an Open End Mortgage?
At the end of the day an open-end mortgage is still a mortgage and you have the option to refinance it. However, you should make note of whether or not the lender has a prepayment penalty in place.
Are there prepayment penalties associated with an open-end mortgage?
Prepayment penalties will vary from lender to lender and will depend on the terms set within your mortgage. It’s recommended that you check with your lender whether or not your open-end mortgage has a prepayment penalty. In today’s lender environment, most lenders have completely gotten rid of prepayment penalties. However, with unique mortgage products, prepayment penalties may exist. As such, it’s recommended that borrowers check the terms and conditions associated with their mortgage.