An open mortgage lets you prepay, refinance, or pay off your balance at any time without a prepayment penalty, but it usually carries a higher interest rate. A closed mortgage offers a lower rate in exchange for limits on extra payments and a penalty if you break the term early.
Choosing between an open and a closed mortgage comes down to a single trade-off: flexibility versus cost. An open mortgage lets you prepay, refinance, or pay off your mortgage at any time without a prepayment penalty, but it generally carries a higher interest rate. A closed mortgage gives you a lower rate in exchange for limits on extra payments and a penalty if you break the term early. Neither type is better in the abstract — the right answer depends on how soon you might need to move, refinance, or pay the balance down.
| Feature | Open mortgage | Closed mortgage |
|---|---|---|
| Interest rate | Usually higher than a comparable closed term | Usually lower |
| Extra payments | Unlimited, at any time | Capped by the prepayment privileges in your contract |
| Paying off the balance | No prepayment penalty | A prepayment penalty applies if you go beyond your privileges |
| Breaking the term early | You can pay out and leave without a charge | Generally three months' interest or the interest rate differential, whichever is greater |
| Typical length | Often short terms, though longer open terms exist | Commonly one to five years, sometimes longer |
| Suits borrowers who | Expect to sell, refinance, or receive a lump sum soon | Plan to stay put and want the lowest ongoing cost |
The table covers the essentials. The rest of this guide explains the mechanics behind each row, how prepayment penalties are actually calculated, and the situations where the cheaper-looking option ends up costing more.
How an open mortgage works
With an open mortgage you can make a lump-sum payment, raise your regular payment, refinance, or pay the entire balance off at any time without triggering a prepayment penalty. That freedom is the product. The lender accepts that your money may leave before the term ends and prices that risk into the rate, so an open term almost always costs more per dollar borrowed than a closed term of the same length from the same lender. Rates vary by lender and by province, so compare the actual numbers rather than assuming a fixed spread.
Open mortgages are typically used for short, uncertain periods — a bridge while a home sale closes, a few months while an inheritance or bonus arrives, or a renovation whose timing is unclear. Some lenders offer a convertible feature: you start open, then lock into a closed term later without paying a penalty at the moment of conversion. That combination gives you breathing room early in the term and the lower closed rate once your plans firm up.
Because the rate is higher, holding an open mortgage for a long time can cost more than the prepayment penalty you would have paid on a closed term. That comparison — extra interest paid versus penalty avoided — is the calculation that matters. The Financial Consumer Agency of Canada's overview of mortgages is a useful starting point for how terms, rates and features fit together.
How a closed mortgage works
A closed mortgage is the standard product in Canada, and most borrowers end up with one. You commit to a term — commonly one to five years, though shorter and longer terms exist — and in exchange you get a lower interest rate than an open mortgage of comparable length. In return, your ability to prepay is capped by the privileges written into your contract.
Those privileges usually combine a few features: increasing your regular payment by a set percentage once a year, making an annual lump-sum payment up to a set percentage of the original principal, and doubling up a payment. The exact percentages, limits and timing vary by lender and by product, so read the terms rather than assuming. Stay inside the privileges and you pay nothing extra. Go beyond them — by paying the mortgage out completely, for example — and a prepayment penalty applies.
Closed mortgages come in fixed-rate and variable-rate versions. Both restrict prepayment, but they are penalised differently. A closed variable-rate mortgage typically carries a penalty of three months' interest on the outstanding balance, and its rate moves with the lender's prime rate, which in turn responds to the Bank of Canada's published interest rates. A closed fixed-rate mortgage can carry a much larger charge, because the lender compares your contract rate with current rates.
Prepayment penalties, explained
A prepayment penalty is compensation to the lender for interest it expected to earn but will not receive. On a closed fixed-rate mortgage, lenders generally charge the greater of two amounts: three months' interest on the outstanding balance, or the interest rate differential. Whichever figure is higher is the one you pay.
Three months' interest
This is the simpler calculation. The lender takes your outstanding balance and multiplies it by your mortgage rate for a three-month period. On a large balance it is still real money, but it is predictable and easy to estimate. It is also the usual penalty on closed variable-rate mortgages and on many short-term closed fixed mortgages.
Interest rate differential
The IRD is where penalties get expensive. The lender estimates the interest it loses when you pay out early and charges you for it. The idea is to compare the rate on your mortgage with the rate the lender could now charge someone else for the remaining term, then apply the difference to the balance for the time left. Institutions differ in the discount rates and posted rates they use, so two lenders can produce very different IRD figures on the same mortgage, on the same day.
The penalty is calculated on the outstanding balance, not the amount you originally borrowed, and it shrinks as the term runs down. It also grows with the size of the balance, which is why breaking a large mortgage early in a term is the most expensive scenario. Federally regulated lenders must disclose how they calculate a prepayment penalty, and should give you the actual charge in writing before you pay it; the Financial Consumer Agency of Canada explains these obligations in its information on loans. Ask for the figure in dollars before you commit to anything.
When each type makes sense
An open mortgage tends to suit borrowers with a defined, near-term event: selling within months, a known payout from the sale of another property, a maturing investment, or genuine uncertainty about how long they will stay. The higher rate is the price of not being locked in, and if the open period is short, that extra cost can be modest in dollar terms compared with the penalty it avoids.
A closed mortgage tends to suit borrowers who are settled. If you expect to stay in the home and stay in the term, the lower rate works in your favour every month, and the prepayment privileges give you reasonable room to pay down faster. Most borrowers never exceed those privileges, so the penalty never applies.
The decision changes if you are buying with help from someone else. A co-signer is on the hook for the debt, and the term and prepayment rules you choose affect them too, not just you. If that is your situation, it is worth understanding what co-signing a mortgage involves before the paperwork is signed. If you are also carrying higher-interest debt and wondering whether to pay it down first, note that bad-credit loans in Canada are priced very differently from mortgage debt, so lump-sum decisions deserve a side-by-side comparison.
What to check before you sign
- The prepayment privileges in writing. Ask what percentage of the original principal you can prepay each year, when the window opens, and whether increasing your regular payment counts against the same limit.
- The penalty formula. Ask whether the lender uses three months' interest, an interest rate differential, or the greater of both, and which rates feed into the IRD. Get it in the commitment letter.
- A dollar estimate. Ask the lender to run the penalty on your actual balance for a hypothetical date 12 or 24 months out. A formula is abstract; a number is not.
- Portability and blending. If you might move before the term ends, ask whether the mortgage can be ported to a new property or blended into a new term. Either may avoid a penalty entirely.
- Convertible and hybrid options. A hybrid mortgage splits your balance between fixed and variable portions, which can provide partial flexibility. A convertible open mortgage lets you lock in later without a penalty at conversion.
- Your real timeline. The best predictor of whether you need an open mortgage is an honest answer to how long you plan to keep the property and the mortgage. A payment calculator helps you see what each option costs per month.
Common mistakes
- Choosing an open mortgage for the entire term "just in case" and paying a higher rate for years to avoid a penalty that may never have applied.
- Assuming the penalty is three months' interest when the contract actually uses an interest rate differential, which can be several times larger.
- Confusing annual prepayment privileges with a penalty-free payout. Prepayment limits usually do not let you discharge the mortgage early without a charge.
- Overlooking portability. If you sell and buy in the same market, porting the mortgage may avoid the penalty altogether.
- Not asking for the penalty in dollars. Two lenders with similar headline rates can produce very different IRD figures.
- Ignoring the effect on a co-signer, who remains responsible for the debt if payments stop, regardless of which mortgage type you chose.