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Open-end Mortgage

DEFINITION

An ‘open-end mortgage’ is a unique mortgage that permits the borrower (mortgagor) to request for additional funds based on the same loan up to a set maximum limit sometime in the future.

EXPLANATION

You should be aware that the security attached to an open-ended mortgage is real estate property for which the borrower has a title. The funds obtained through an open-ended mortgage can only be used to invest in the property that is attached as security for the mortgage.

The application process for such mortgages is very similar to that for other types of credit and the applicant’s credit score as well as their credit profile play a crucial role in determining the loan terms.

The structure of an open-end mortgage

Basically, once a borrower successfully applies for an open-end mortgage, they are usually approved for a specific maximum amount that they can access over a specified period. Once the loan is approved, the borrower can request for a smaller amount than the maximum, which they could use to cover the initial cost of their property.

By requesting for a smaller amount, the borrower will reduce their overall interest costs as they are only required to pay interest on the outstanding principal. The borrower can request for the rest of the loan amount at any time in the future so long as the time period stipulated in the loan terms has not elapsed.

Advantages of open-end mortgages

The main advantage of open-end mortgages is that the borrower is not required to meet any specific targets in order to receive the remaining funds. The open-end mortgage also allows the borrower to apply for additional funds without going through the loan application process afresh.

Another advantage is that the mortgagor saves all the costs that would be incurred when applying for additional funds through the issuance of a new loan such as appraisal fees and closing costs. By using an open-end mortgage, the borrower cane easily apply for additional funds without incurring any more costs.

Some realtors believe that the terms of an open-end mortgage are more favorable than those for a standard home improvement loan.

How an open-end mortgage works

For example, we have a borrower (mortgagor) who applies and qualifies for a $150,000 open-end mortgage and is awarded the rights to the full amount. The borrower then decides to request for $90,000 as his first distribution, which he uses to purchase a home. The initial distribution usually has a fixed interest rate, which in this case we assume is set at 5.0% based on current interest rates. The borrower will begin paying interest on this amount once he receives the loan.

Let’s say that after four years, the mortgagor decides to apply for the remaining amount in order to make some home improvements, which in this case amounts to $60,000. The additional funds will be added to the outstanding loan principal and he will start paying interest on the combined amount. If the open-end mortgage has a fixed interest rate, he will continue paying the 5.0% interest rate. However, if the loan has a variable interest rate, then he will be paying 5.0% interest on the outstanding balance from the initial distribution, while a new rate will apply to the additional $60,000.

A word of caution

The lender should always conduct a lien search before authorizing any additional distributions to ensure that there are no other liens on the property with priority over the additional funds.

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