What Is An Open End Mortgage And Should You Consider Getting One?

Anyone who’s purchased a home knows that it comes with expenses beyond the listing price alone. When you buy a house, you have to plan for a down payment, closing costs and moving expenses.

And once you move into the house, you may end up paying even more money for home improvements. Many homeowners will put these expenses on a high-interest credit card, but other options are available. For instance, you could consider taking out an open-end mortgage. While Rocket Mortgage^® does not offer open-end mortgages, it’s important for anyone researching these types of loans to understand what they are and how they function.

An open-end mortgage is also sometimes called a home improvement loan. It’s kind of like a mortgage and home equity line of credit (HELOC) rolled into one loan when a property is purchased. However, open-end mortgages are a less common type of home loan.

With an open-end mortgage, borrowers take a loan for the maximum amount they qualify for — even if they don’t need it all to make the real estate purchase. The unused portion is available to the borrower after the purchase, but it can only be used to improve the property. Borrowers are not charged interest on the unused money until they access it.

An open-end mortgage often works best when home buyers or investors choose a fixer-upper property that requires serious renovations. For instance, let’s say you’re approved to take out a $400,000 mortgage.

The home you end up purchasing costs $300,000, but it needs some work done. With an open-end mortgage, you’ll still be approved to take out the entire $400,000, but you’ll only pay interest on the money you actually end up using.

After you buy the house, you end up putting $50,000 worth of work into it. Since you only spent $350,000, that’s the amount you’ll pay interest on.

You can use our mortgage calculator to see how your mortgage payment will be affected by tapping into the unused loan proceeds. However, open-end mortgages are not allowed in every state.

Open-end mortgages are determined by the laws in the state where you live. States are primarily responsible for laws surrounding property transactions, which are executed by municipalities.

Legally, the deed must reflect the amount of the debt of the property accurately. Because the amount of indebtedness can change, a special type of deed is required.

An open-end mortgage could be the right choice, depending on your situation. Here are some of the pros and cons you should consider before moving forward with the option.

Pro: Have Money At The Ready For Repairs And Renovations

Many new homeowners will buy a property that needs a little work at a discounted price. This can be a more affordable way to become a homeowner.

However, fixing up a house can be expensive, and many people don’t have the extra funds available once they move in. An open-end mortgage eliminates that problem – you’ll already have the money ready for repairs and renovations once you move in.

Pro: Only Go Through Mortgage Application Process Once

If you’re looking for ways to fix up your home, there are many financing options available. For instance, you could buy a home and then take out a home equity loan or HELOC. However, the advantage of an open-end mortgage is that you only have to go through the loan application once.

Pro: Pay Interest Charges Only On What You Actually Borrow

And finally, one of the biggest advantages of an open-end mortgage is that you’ll only pay interest on the funds you actually borrow. For instance, let’s say you’re approved for a $500,000 mortgage at an interest rate of 4.75%.

You end up purchasing a $350,000 home and spend $75,000 to fix it up. That means you’ll only pay interest on $425,000, not the full amount you were approved to borrow. 

Con: Not Available In All States

Ultimately, state law determines availability, and not all states allow open-end mortgages. So, this loan type may not even be an option for you.

Con: Preapproval Doesn’t Guarantee Affordability

Just because the bank will approve you to borrow a certain amount of money doesn’t mean you can afford it. You should always rely on your budget to determine what you can afford, not a lender’s maximum approval amount.

Con: You Can Only Borrow Up To Your Preapproval Limit

Once you’re approved to borrow a certain amount of money, that mortgage amount can’t be revised upward. If you think you should be approved for more, you’ll have to fill out a new application and go through underwriting all over again.

Con: Draw Period Limits How Long You Can Borrow The Money

Your draw period determines how long you have to borrow the money. This draw period is determined by how much you were preapproved to borrow and the initial terms of the loan. The downside of this is that it could encourage homeowners to take on more debt before they are ready.

Before you take out an open-end mortgage, you need to understand that they could end up costing more over the loan term. Here are some things you should consider first.

Conforming Vs. Non-Conforming

A conforming loan is a mortgage that meets the guidelines set by Fannie Mae or Freddie Mac. A non-conforming loan is a mortgage that doesn’t meet Fannie Mae and Freddie Mac’s guidelines. Conforming loans tend to cost borrowers less than non-conforming loans.

Both government-sponsored entities will purchase some open-end mortgages, but only if the loan terms allow the mortgage owner the discretion to deny an applicant’s access to more funds and no advances have been made since the original purchase.

Interest Rates Now Vs. Then

Interest rates move up and down, so the rate you’re charged for an open-end mortgage could be higher than what you’d receive for a refinance, HELOC or personal loan.

If you’re interested in taking out an open-end mortgage, the application process is similar to a traditional mortgage. You’ll need to provide your lender with proof of income, employment, and a list of your assets. Your lender will also check your credit score to get a sense of your lending history.

However, not all lenders offer open-end mortgages (including Rocket Mortgage^®), and the lenders that do can set their own requirements. But here are some general guidelines you should plan to meet: 

• A credit score of 660 or higher
• A debt-to-income ratio of 43% or less
• A loan-to-value ratio of 80% or less

It can be challenging to find lenders that offer open-end mortgages, even in states where they are allowed. For instance, Rocket Mortgage does not offer open-end mortgages. If you can’t find resources in your area, you might consider working with a mortgage broker to help connect you with those offering this type of loan.

An open-end mortgage differs from most conventional mortgages in that they do not ordinarily provide funds in excess of those needed to purchase the home, even if the funds are used to make a home livable. If you can’t get an open-end mortgage, there are other funding options available.

For instance, you might consider taking out a Fannie Mae HomeStyle Renovation Loan. With this loan, the money is distributed at closing to pay for the home. In order to access additional funds for home renovations, an approved contractor must submit their plans to access the draw.

The advantage of this is that it limits fraud, but it can be more tedious than taking out an open-end mortgage. Rocket Mortgage does not offer Fannie Mae HomeStyle Renovation Loans.

FHA Loans

The FHA does not offer open-end mortgages. However, when a home buyer uses an FHA home loan to buy a home in need of repair, they can also get an FHA 203(k) loan to pay for repairs and then combine both loans into one affordable monthly payment.

VA Loans

Service members of the U.S. Armed Forces and Reserves who qualify for Department of Veterans Affairs (VA) home loans also can access VA renovation loans that allow them to buy and rehabilitate homes in need of TLC.

USDA Loans

When you take out a USDA loan, the USDA also offers renovation loans. USDA borrowers can also take advantage of the USDA’s section 504 home repair program.

It’s important to note that Rocket Mortgage does not offer any of the above renovation loans.

An open-end mortgage can help buyers who qualify to buy a fixer-upper while also providing the money to fund renovations and repairs. But if it’s not available in your state, you can always get a traditional mortgage and seek out a refinance when you can afford to make repairs. If you’re ready to apply for a mortgage, you can get started online today!