If you’re shopping around for a mortgage to use to purchase your first investment property, you may be wondering what type best suits your needs and objectives as a real estate investor.
The two most common standard options are open and closed mortgages. There are benefits and drawbacks associated with both. Whether you opt for an open or closed mortgage ultimately depends on your ability to pay down the loan.
·Open mortgages are repaid over a relatively short-term period and offer higher, variable interest rates. With an open mortgage, you can pay down the balance of the loan as quickly as you choose, so long as it’s paid off by the end of the loan term.
·Closed mortgages, meanwhile, have lower interest rates and longer loan terms. If you attempt to pay off the mortgage before the end of the loan term, however, you’ll have to pay stiff penalties.
If you’re planning on holding the property long-term and using it to generate passive income through rental, a closed mortgage is likely the best option for you. If you’re hoping to sell off the asset in a relatively short period of time and use it to leverage another investment, an open mortgage may make sense.
Defining a closed mortgage
Closed mortgages are the most common types of mortgages most homeowners and first-time real estate investors use to finance their property purchases.
Depending on your credit, the price of the property and other determining factors, most closed mortgages feature 25 to 30-year loan terms and fixed interest rates between 3 percent and 5 percent.
Closed mortgages offer stable monthly payments you can easily use to factor your business expenses and calculate your actual income and cash flow. In most cases, closed mortgages impose financial penalties if you attempt to pay down the balance of the loan in addition to your scheduled monthly payments.
In most cases, closed mortgages allow you to pay down a maximum of 15 percent of the value of your loan within a calendar year. The exact terms are laid out in your loan agreement.
If you’re not expecting a sudden windfall of cash, or if you’re not planning on selling your investment property at any time soon, it’s likely that the closed mortgage model is right for you.
Benefits of an open mortgage
When you agree to an open mortgage, you can pay down or renegotiate the mortgage terms at any time, without worrying about incurring penalties.
The repayment period for most open mortgages lasts between one and five years. The variable interest rate may fluctuate significantly, depending on market conditions, which could lead to relatively unstable monthly payments.
If you’re expecting a cash windfall at some point in the next five years, or if you’re planning to renovate and sell your investment property for a profit in the near future, an open mortgage may be right for you.
It’s also important to note, one of the primary benefits of the open mortgage model is its flexibility. If you need to, you can transition to a closed, fixed-rate mortgage with very little issue at any time.
Of course, purchasing a piece of property as an investment, rather than as a primary residence, often comes with its own unique set of challenges.
When deciding the type of mortgage product that best suits your needs, it’s important to consider the different factors that may affect your investment down the road.
Many lenders view investment properties as extra risky. This means that you might not be eligible for traditional mortgage rates with your investment property, or they may charge you a higher interest rate. Additionally, many lenders will want to see larger down payments on rental properties – usually exceeding 30 percent.
There are also tax considerations to take into account. Depending on your tax status and the province in which you and your rental property are located, you may be subject to special investment taxes. Or, if you sell your property at a profit, you may have to pay a steep capital gains tax.
Ultimately, both open mortgages and closed mortgages have a number of benefits that make sense for different types of investors. It’s advisable to discuss your mortgage options with a financial expert before deciding which type of product is right for you, given your own financial situation and objectives.