What is a Closed Period?
A Closed Period in a mortgage is a specific term during which a mortgage cannot be prepaid. This feature is often found in mortgages on commercial properties but is less common in residential mortgages. The mortgage, however, is usually assumable by subsequent buyers of the property.
Example of a Closed Period in Action
Imagine a mortgage on an office building for $10 million at 6% interest with a 10-year closed period. After the mortgage was originated, interest rates generally dropped to 4%. Although the borrower wanted to pay off the loan early and refinance at the lower rate, they were prevented from doing so during the closed period.
Assumable Mortgage
This closed-period schema is often blended with the feature of an assumable mortgage, meaning the mortgage can be passed on to subsequent buyers of the property. This allows for continuity in financing terms despite the closed period restriction.
Implications of a Closed Period
The closed period offers stability to lenders by ensuring a consistent stream of interest payments. For borrowers, it provides clarity on payment schedules but restricts their ability to adjust to market changes regarding interest rates.
Why Do Closed Periods Exist?
These periods primarily exist to protect lenders from interest rate drops after loan origination. By locking in the borrower for a set duration, lenders can maintain financial predictability and mitigate risks associated with declining interest rates.
Pros and Cons of Closed Periods
Pros for Borrowers
- Predictable payment schedule
- Potentially lower initial interest rates because of long-term lender security
Cons for Borrowers
- Inability to refinance for a lower interest rate
- Potential costs associated with transferring the assumable mortgage
Pros for Lenders
- Stable long-term revenue
- Reduced risks from fluctuating interest rates
Cons for Lenders
- May deter some potential borrowers seeking flexibility
FAQs
What types of properties usually have closed periods?
Closed periods are more commonly found in commercial property mortgages but are rare in residential mortgages.
Can a closed period mortgage be refinanced?
Not until the end of the closed period. However, the mortgage can sometimes be assumable which allows subsequent buyers to take over the remaining loan period under the same terms.
Are there penalties for breaking a closed period?
Typically, yes. Breaking a closed period before its end can result in significant financial penalties.
Does a closed period affect monthly payments?
No, a closed period mainly restricts early payoff but does not typically affect pre-determined monthly payments.
Related Terms: prepayment, mortgage refinancing, commercial mortgage, interest rates, assumable mortgage.
