An open-end mortgage is a type of home loan in which the total amount of the loan is not advanced all at once, but rather, used from time to time as needed. Unlike traditional mortgage loans, the loan allows the prospective buyer to purchase a home without using the full loan amount they qualify for. They then can continue to draw funds from the loan once they've moved into the home.
Understanding open-end mortgages is helpful for homebuyers and real estate professionals looking for financing options. In this guide, you’ll learn how an open-end mortgage loan works and whether it's a good idea for you.
Definition and Examples of an Open-End Mortgage
An open-end mortgage is a unique type of home loan in that the borrower has the opportunity to use the funds from the loan as needed, even after they purchase the property. Like a traditional mortgage loan, it gives the borrower enough cash to purchase a home. But in this case, it allows the borrower to increase the amount of the loan at a later date, drawing from it like you would with a home equity line of credit (HELOC).
For example, let's say you're buying a house for $300,000, but you qualify for an open-end mortgage worth $400,000. Until you take additional draws, you'll only make principal and interest payments on the $300,000 you initially received.
Then if you take a draw of $25,000, you'll start making payments on that amount combined with the existing principal balance. The same goes for any additional draws you take in the future.
- Alternate names: open-end loan, mortgage for future advances
How an Open-End Mortgage Works
An open-end mortgage works like a hybrid between a traditional mortgage and a HELOC, except you only have to apply once instead of adding a second lien to your home through a separate HELOC.
You'll start with a maximum loan amount you can borrow over time. A portion of that goes toward the cost of buying the house, and the remainder can be taken at a later date. Unique to an open-end mortgage, the remaining funds must be used for improvements or changes to the home. Like a HELOC, you can draw from the additional available credit, pay it off, and draw again.
The amount available that you can borrow is limited to what you were approved for when you first took out the loan. It will depend on your home's value, as well as the amount of your first mortgage.
Even though you access the mortgage at two different times—first to purchase the home, then to make home improvements—you'll still have just one loan and one monthly payment to make. To accommodate the new balance, the mortgage term may be extended or the monthly payment may increase. Then, once the loan is completely repaid, the borrower may need to submit a request to cancel the mortgage.
Keep in mind that the requirements and structure of open-end mortgages may vary depending on where you live. State laws determine how open-end mortgages can be provided and defines priority of property liens when there are multiple liens.
Applying for an open-end mortgage is similar to that of other credit products, as terms of the loan are determined by the borrower’s credit score and credit profile. Before applying, it’s best to ensure your credit score is in good standing. Credit score requirements specifically depend on the lender, but generally, the minimum FICO score required to qualify for a conventional mortgage is about 620.
Alternatives to an Open-End Mortgage
An open-end mortgage offers the same benefits you might get if you buy a home using a traditional mortgage loan then apply for a home equity loan or HELOC.
If you go that route, there will be two application processes and two sets of closing costs. But you'll be able to decide how much you need when you need it, or even if you need it at all. With a home equity loan, it's just one lump-sum disbursement, which may or may not work with your plans.
Pros and Cons of an Open-End Mortgage
Flexibility with financing needs
Interest accrues only on what you've borrowed
Limited draw time
Borrowing limits are set
They are not offered by every lender
- Flexibility with financing needs: If you're planning to buy a home and qualify for more than you need to buy it, an open-end mortgage can give you the flexibility to borrow more in the future for renovations and other costs associated with the property.
- Interest accrues only on what you've borrowed: As with a HELOC, you only have to pay interest on the portion of the open-end mortgage loan amount that you've actually used. You'll also avoid the costs associated with refinancing and higher interest rates that typically come with second mortgages.
- Limited draw time: You may be limited on how long you can take additional draws on your open-end mortgage. This will depend on how much funding you initially received and the terms of the loan.
- Borrowing limits are set: Your total loan amount is set when you first get approved. If you need more money than what you initially qualified for, you may need to apply for a second loan anyway. Also, by spreading out the loan payments over a longer period of time, you may end up paying more in interest.
- They are not offered by every lender: If you run a quick internet search for open-end mortgages, you'll have a hard time finding lenders that offer them. If you're interested in getting one, you may need to work with a mortgage professional to find what you need.
Is an Open-End Mortgage Worth It?
An open-end mortgage can be worth considering if you qualify for a loan that's larger than the amount you need to borrow to initially buy the home.
However, considering the limitations on how you can use the money and the fact that they're typically more expensive than traditional mortgage loans, it may not make sense if you don't have plans to invest in your home in a significant way.
If you think you might want to tap your home equity at some point but don't have specific plans, it may make more sense to opt for a traditional mortgage loan then apply for a home equity loan or HELOC when you need it.
- An open-end mortgage is a type of home loan in which the total amount of the loan is not advanced all at once, but rather, used for future home-related improvements as needed.
- Open-end mortgages combine the benefits of a traditional mortgage and a HELOC.
- Open-end mortgages can provide flexibility but limit you to what you were initially approved for.
- It is best to speak with a mortgage professional to get more information about whether an open-end mortgage is right for you.