A closed-end mortgage, also known as a”closed” mortgage, is among the more restrictive home loans you can get. Having this kind of loan, you can’t renegotiate the mortgage, refinance your home or take out another mortgage or a home-equity loan without receiving permission from your lender or paying a fee.
What makes these mortgages”closed” is that the mortgage principal–the amount of money that you obtained from your lender to purchase the home–is the only money you are allowed to borrow from the home. Say your house is worth $450,000, and you still owe $250,000 on the mortgage. The $200,000 gap between these two figures is your equity, or the section of the home that you”own,” while the lender owns the rest. With traditional”open-end” mortgages, you would be free to borrow from that $200,000 in the form of a home-equity loan. You would get it done by setting up the home as security for the new loan. In effect, the home becomes security for two loansthe original mortgage and the equity loan. Having a closed-end mortgage, you can’t use the home as collateral for any additional loan except the original mortgage.
Along with the limitations on further borrowing, closed-end mortgages generally can’t be prepaid without paying a substantial”break fee” or”breakage charge” to the mortgage lender to complete the loan contract. This fee may phase out over time; it depends on the loan. The limits on your ability to borrow from equity may not concern you when you buy your house, but they may later on. In that scenario, you may consider refinancing–obtaining a new, open-end mortgage to pay off the mortgage. The lender is not likely to just let you walk away from the contract, thus the break charge.
The rationale a borrower would agree to such possibly onerous loan terms is simple: to get a better interest rate on the mortgage. After the homeowner agrees to refrain from borrowing some other money against the home, it reduces the risk to the lender. If something were to happen–like the borrower defaulting on the mortgagethe original lender won’t need to”get in line” with other creditors with a claim on the home. On any loan, decreased risk to the lender translates into a lower interest rate for the debtor.
Closed-end mortgages may be perfect for homeowners who are ready to settle down for the long term. If you intend to remain in your home for a fantastic while and expect to have enough assets that you won’t need to tap your home equity for money, then you may be willing to undertake the closed-end devotion in exchange for the long-term savings that will come from a lower rate.
Concerned that borrowers were putting themselves to closed-end mortgages without completely understanding the limitations, the Federal Reserve Board in late 2009 introduced regulations to require additional disclosure at program time. These disclosures include giving loan applicants a Federal Reserve-produced pamphlet list questions they ought to inquire about their loan terms.