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 pricez. When you buy a house, you’ll likely have to plan for a down payment, closing costs and moving expenses.

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. If you’re wondering how to pay for renovations when buying a home, you could consider taking out an open-end mortgage.

While Rocket Mortgage® doesn’t offer open-end mortgages, it’s important for anyone researching these types of loans to understand what they are and how they function. Let’s take a look at what open-end mortgages are, how they work and the pros and cons of getting one.

What is an open-end loan?

An open-end mortgage is a type of mortgage that lets borrowers take out the maximum loan amount they qualify for to buy a house and pay for home improvements. The portion of the loan that isn’t used to buy the house, also called “future advances,” is available to the borrower after the real estate transaction is complete.

The unused portion of the mortgage can only be used to fund home improvements. Borrowers are not charged interest on the unused money until they access it.

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

How does an open-end mortgage work?

An open-end mortgage often works best when home buyers or investors buy a fixer-upper that requires serious home renovations.

For instance, maybe you’re approved to take out a principal amount of $400,000.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 loan. However, you’ll only pay interest on the money you use to purchase the home and to cover your renovation costs.

After you buy the house, let’s say you put $50,000 worth of work into it. Since you only spent $350,000, that’s the total loan amount you’ll make principal and interest payments on.

You can use a mortgage calculator to see how your mortgage payment will be affected by tapping into the unused loan proceeds. Keep in mind that open-end mortgages aren’t available in every state.

Pros and cons of open-end loans: At-a-glance

Pros of open-end mortgages

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

One monthly payment for the home purchase and repairs

When you finance with an open-end mortgage, you only have one loan and one monthly payment. This payment covers the cost of the home purchase as well as any home repairs and renovations. Open-end mortgages also help home buyers avoid taking out two types of loans: one to finance the house and another to pay for any home renovation costs.

If you’re looking for a way to streamline your monthly mortgage payments while also funding a home renovation, an open-end mortgage might be right for you.

You have funds available For home renovations

Many new homeowners will buy a property that needs a little work at a discounted price. This route 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 when you move into your new home.

You only go through the 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 loan¹ or HELOC once you have built up some equity.

However, the advantage of an open-end mortgage is that you only have to go through the loan application process once. This can cut down on the time you’d otherwise spend applying for other home renovation financing options.

You only pay interest on the money you need

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. 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 (the $500,000 loan amount).

Cons of open-end mortgages

Financing a property with an open-end loan also has its downsides. Here are some of the disadvantages of open-end mortgages:

Open-end loans aren’t available in all states

Ultimately, state laws determine whether open-end mortgages are available to borrowers. Not all states and mortgage lenders allow open-end mortgages. So, this loan type may not even be available to you when you’re comparing home financing options.

Mortgage preapproval doesn’t guarantee affordability

A bank or mortgage lender may approve you for a certain amount of money that you can’t necessarily afford. You should always rely on your budget to determine how much you can realistically afford for the home purchase and any potential renovations, not a lender’s maximum approval amount.

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 mortgage application and go through the underwriting process again.

Draw period limits how long you can borrow the money

Your draw period determines how long you have to borrow the money. The draw period is determined by how much you were preapproved to borrow and the initial terms of the open-end loan. The downside of this is that it could encourage homeowners to take on more debt before they’re financially prepared to do so. 

Who qualifies for open-end mortgages?

If you’re interested in taking out an open-end loan, the application process is similar to that of 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. Here are some general guidelines you should plan to meet when applying for an open-end home loan:

• A credit score of 620 or higher
• A debt-to-income ratio (DTI) of 43% or less
• A loan-to-value ratio (LTV) of 80% or less

Do open-end mortgages cost more over the loan term?

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

Conforming vs. non-conforming loans

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 on open-end loans vs. other loan types

Interest rates move up and down, and the rate you’re charged for an open-end mortgage could be higher than what you’d receive on other mortgage or home renovation products. Compare interest rates on open-end mortgages and on products like cash-out refinances, home equity loans, HELOCs and personal loans.

Alternatives To Open-End Mortgage Loans

An open-end mortgage differs from most conventional mortgages in that conventional mortgages 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 financing options available. Let’s take a look at some alternatives to open-end loans.

Fannie Mae HomeStyle Loan

With a Fannie Mae HomeStyle Loan, the money to pay for the home is distributed at closing. In order to access additional funds for home renovations, an approved contractor must submit their plans to access the “draw.” After the work is completed, the contractor receives the funds for the home improvements.

The advantage of a HomeStyle loan 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 203(k) Loan

The Federal Housing Administration (FHA) doesn’t offer open-end mortgages. However, when a home buyer uses an FHA 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.

The FHA 203(k) loan has more flexible borrower requirements than other types of home loans. This can be ideal for home buyers with less-than-perfect credit or limited funds for a down payment.

VA Renovation Loan

Service members of the U.S. Armed Forces and Reserves and qualifying surviving spouses who are eligible for a Department of Veterans Affairs (VA) loan also have access to a VA renovation loan. This loan can be used to buy and rehabilitate a house that might require some home improvements or repairs.

VA renovation loans have the same benefits and borrower requirements as traditional VA loans, including a 0% down payment requirement, a minimum 620 credit score and a certificate of eligibility (COE).

USDA Section 5 Home Repair Program

When you take out a USDA loan, the USDA also offers renovation loans. For example, USDA borrowers can take advantage of the USDA’s Section 504 Home Repair Program. This program is designed to upgrade, repair or modernize the single-family homes of qualified borrowers.

A Section 504 Home Repair Loan can be used to fix or replace important features in a home, including the foundation, septic system and insulation. It can also be used to finance projects that remove safety or health hazards from the residence.

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

Open-end mortgage FAQs

You might have more questions if you’re considering an open-end mortgage loan. Review the FAQs below to help clear up some of your outstanding questions.

What’s the difference between a traditional mortgage and an open-end mortgage?

A conventional mortgage loan is a single lump sum of money used to finance a home purchase. An open-end mortgage, on the other hand, is a type of mortgage that allows borrowers to take out the maximum amount they qualify for, even if they don’t need it all to make the real estate purchase.

The money that is not used to buy the house can be used to fund renovations and repairs on the property.

Who offers open-end loans?

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.

What is an open-end mortgage deed?

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 on a house must reflect the amount of the debt owed on a property accurately. Because the amount of indebtedness can change, a special type of deed is required on a house financed with an open-end loan.

The bottom line: An open-end mortgage lets you pay for renovations when buying a house

An open-end mortgage can help buyers purchase a fixer-upper while also providing the money to fund renovations and repairs. If an open-end loan isn’t available in your state, you can always get a traditional mortgage, explore different government-backed loan programs or check out your loan refinancing options.

If you’re ready to apply for a mortgage, start the approval process today.

¹Home 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. 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. This is not a commitment to lend.