A mortgage that does not provide for any
prepayment of principal during the term.
Considerable confusion exists concerning
the topic of a mortgagor’s ability to make
prepayments on a mortgage. When a mortgagor
signs a mortgage document, he/she has
essentially entered into a contract with the
mortgagee. Unless the mortgage terms or
related documentation provides otherwise,
the mortgagor has agreed to make payments
according to a specified schedule and the
contract is written to run for a stated
period. During the term of such contracts,
the mortgagor who decides to make extra
payments, or discharge the loan in its
entirety before the end of the term is in
effect asking for an amendment to the
agreement. Such amendment is possible, but
only by mutual consent. The mortgagee is
entitled to demand costs for giving consent
or to refuse the consent entirely.
The Interest Act, a federal statute, is
very specific regarding the closed period of
a mortgage. If no prepayment privilege is
stated in the mortgage document itself, then
the borrower can only repay a conventional
closed mortgage loan in certain situations.
With special permission of the
mortgagee and subject to conditions
imposed by the mortgagee.
A loan to an individual can, by law,
be repaid after five years, subject to
payment of three months interest penalty
(bonus).
A loan to a corporate borrower
cannot be prepaid without the permission
of the lender.
An open mortgage usually allows the
borrower to make prepayments at any time in
any amount during the term of the contract
and in some cases, a penalty charge will be
attached to such prepayments. Traditionally,
a higher interest rate is charged for an
open mortgage.
Consumers often use the phrase open
mortgage or closed mortgage, when in fact
only the term is open or closed. A closed
term means that the mortgage cannot be paid
fully or partially before the term expires.
From the lenders point of view, the
mortgagor has agreed to borrow the money for
a specified period at a specific interest
rate. Repaying the loan before it is due
breaks the contract. If the borrower wishes
to prepay the loan, all interest owing until
expiry of the term must be paid.
An open mortgage provides for the
prepayment of the principal, however, the
amount and terms of prepayment will vary.
Sometimes, mortgages will be described as
fully open (payment of the amount owing), or
partially open (specified times and amounts
permitted). The issue of prepayment
privileges and associated penalties requires
clarification. Most lenders usually charge
three months’ interest or an interest
differential, if the current rate is higher,
whichever is greater. As a rule, payout
penalties are calculated in simple interest.
Due to the short time period (usually three
months), the simple interest calculation
will be greater than the compounded amount.
A range of prepayment options, with and
without penalties, can be found in the
marketplace. In Nova Scotia, for example, a
statutory provision provides that if a
mortgage executed after June 30, 1985 is
silent with respect to prepayment, it can be
prepaid without penalty at any time. Various
requirements may be stipulated in provincial
legislation.
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