Closed- vs. open-end mortgage: Which is right for you?

When you get a home loan, you have to choose from a wide variety of mortgage types and lenders. A lesser-known decision home buyers face is whether to choose an open-end or a closed-end mortgage.

Closed-end mortgages are what comes to mind when most people think about home loans. They’re far more common. In 2023, of the roughly 10 million home loan applications, 7.7 million were for closed-end loans and just 2.1 million were for open-end loans.

Though Rocket Mortgage® does not offer them, open-end mortgages, which let you borrow additional money, can be helpful for people who want to renovate or upgrade their home after buying it. We’ll break down what you need to know.

What is a closed-end mortgage?

With a closed-end loan, you can borrow only enough money to buy the home, and you’re limited by the home’s appraised value. For example, if a home appraiser says a property is worth $350,000, a lender will not approve you for a loan larger than that amount.

A plus of these loans is that the repayment term and, for fixed-rate loans, your monthly principal and interest payment are set when you get the funds. However, if you want to pay the loan off ahead of schedule, you might have to pay a fee.

Pros and cons to closed mortgages

Closed-end loans are popular for a reason, but it’s also important to consider the drawbacks of closed mortgages before you apply for one.

Pros

Some reasons to get a closed-end loan include:

• Lower interest rates than open-end mortgages.
• They are more widely available, giving you many choices for lenders, including major banks and credit unions.
• Your mortgage payment is predictable for the life of the loan with a fixed rate and, closed term.

Cons

Closed-end mortgages also have some drawbacks to consider before you apply.

• If you need more funding, you’ll have to take out a second mortgage or refinance in the future.
• You may end up with two payments, one for your first mortgage and another for a HELOC.
• You may have to pay an early repayment fee if you pay the loan off ahead of schedule.

What is an open-end mortgage?

Unlike a closed-end mortgage, open-end mortgages allow you to borrow more than the amount you need to buy the home and can sometimes exceed the property’s appraised value.

For example, if you get an open-end mortgage with an approval amount of $500,000, you could use it to buy a $450,000 home and take the additional $50,000 out of the loan to use for home improvements.

That means that you can borrow money from an open-end mortgage multiple times. If you do, your payment could rise; however, these loans typically don’t have early repayment penalties.

These loans are riskier for lenders and less common than closed-end loans. That means they may have higher interest rates and can often be harder to find.

Pros and cons to open-end mortgages

Open-end mortgages can be useful for people who want to renovate a property, but it’s also important to consider the drawbacks before applying.

Pros

Some reasons to apply for an open-end mortgage include:

• You can finance your home purchase and future renovations with a single loan and payment.
• You can typically make extra payments or prepay with no penalty.
• You have more flexibility, borrowing more at your own discretion up to your limit.

Cons

Open-end mortgages aren’t right for everyone, so consider these drawbacks:

• Interest rates are usually higher than for closed-end loans
• There is typically a limited draw period.
• Your payment will change as you borrow more, making it more likely that your payment will quickly rise above affordability.

Alternatives to open-end mortgages

If you are having trouble finding an open-end mortgage but want to buy a home and finance renovations, there are other options available. These loans can be a good fit if you already have a closed-end mortgage or think a closed-end loan is the better choice for you.

• Home equity loan: Home equity loans let you get funds out of your equity in a lump sum.¹  They’re good for projects with predictable costs and large one-time expenses.
• HELOC: Home equity lines of credit give you access to a pool of cash you can draw from multiple times, with the limit based on your home equity. They can be a good fit if you need flexibility in the amount you borrow. Rocket Mortgage currently does not offer HELOCs.
• Cash-out refinance: Cash-out refinancing replaces your existing loan with a new, larger one, letting you pocket the difference as cash and use it for other purposes.²  They can be good if you want to only have one loan payment or already want to refinance your mortgage.
• Home improvement loan: These loans are specially designed to be used for home improvements. They often have flexible loan amounts and rates similar to home equity loan rates.
• FHA 203(k) refinance: FHA 203(k) loans let you combine mortgage and renovation costs into a single loan, much like a cash-out refinance, but for FHA loans and with limits on how you can use the funds.
• Fannie Mae HomeStyle Loan: HomeStyle renovation loans can cover certain home improvement projects, like roofing, plumbing, adding an in-law suite, or improving landscaping.

The bottom line: Open-end mortgages are more flexible

While closed-end loans are far more common, if you want to renovate the home you’re planning to buy, you might want to consider an open-end mortgage. They offer more flexibility, letting you borrow more than the home’s value so you can put the funds toward improving your future property.

While Rocket Mortgage doesn’t offer open-end loans, they’re not right for everyone. If you think a closed-end mortgage is right for you, you can apply for one today.

¹ Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 2/5/2024 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00 (minimum loan amount for properties located in Michigan is $10,000.00). Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Schwab products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. Not available in Texas. This is not a commitment to lend.

² Refinancing may increase finance charges over the life of the loan.