If you’ve owned your home for a while, chances are you’ve built up a good chunk of equity by making mortgage payments. Because your home acts as collateral, that equity’s almost as good as money in the bank. And it can be used to secure a line of credit, so long as you don’t borrow more than the amount of equity you have in your home. A mortgage that allows you to borrow against equity is an open-ended mortgage.
Open-Ended Mortgage Basics
Open-ended mortgages give homeowners the flexibility to use the equity invested in their homes as a source of credit. They can borrow against that amount as needed, then pay down the balance. This arrangement provides a line of credit rather than a lump-sum loan amount: Open-ended mortgages function like your credit card, allowing you to borrow and pay down your debt as needed. A home equity line of credit is a common example of an open-ended mortgage.
Draw Periods and Renewals
Many open-ended mortgages aren’t as flexible as their name implies. Some lines of credit are structured to allow you to tap your equity as much as you like during a fixed period, known as the draw period. At the end of your draw period, you enter your repayment period. At that point you’ll need to start paying off the loans made against your equity, and you'll no longer have access to the credit. Occasionally, open-ended mortgages offer the chance to renew, extending your draw period.
An open-ended mortgage or a home equity line of credit provides homeowners one major advantage: flexibility. Making mortgage payments reduces the amount of money you can put into savings, but open-ended mortgages help turn equity into liquid assets, albeit it at the price of finance charges. This arrangement can be helpful in a pinch -- if you're out of work for a short time, for example. However, it's best suited for borrowers who have a plan on how to repay the credit and can expect a return on their investment, such as farmers who need money for crops.
Many open-ended mortgages are provided on an adjustable-rate basis, so borrowing against your line of credit can be risky. If your interest rate goes up after you take the loan, you might face much steeper finance charges than you expected. That could make repayment difficult. Additionally, if your home’s value tanks after you’ve used a significant portion of your line of credit, your home could effectively be underwater. You'd owe more on the mortgage and the home equity line of credit or open-ended mortgage than the home would be worth.
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