The Difference Between Closed-End & Open-End Credit
To the average consumer, the world of loans, mortgages, and financing can be confusing and stressful. As a broker, it’s important to understand the difference between the different types of credit and their associated loans so you can advise your borrowers on their best path towards homeownership.
Closed-end credit is a type of loan where the borrower receives the sum upfront and is required to pay back the loan at the end of a set timeframe. The amount owed also includes any interest or maintenance fees accrued throughout the duration. Closed-end credit loans will allow for a large sum of money to be lent out at once.
Most mortgages are secured loans and require collateral. To act as collateral, or a guarantee that the debtors will pay back the loan in full, the borrower will agree to put up something valuable they own to forfeit if they breach the contract. In the case of a home loan or mortgage, this collateral is the home itself. Other types of collateral can include a car, a sum invested in a savings account, or a certificate of deposit (CD). With collateral as a form of insurance added to the transaction, the lender can afford to offer less aggressive rates and fees, though this carries with it a lot more risk to the borrower. A good credit score is less necessary with a secured loan, though collateral is absolutely required.
Examples of secured loans include:
- FHA Loans
- VA Loans
- Conventional Loans (Fannie Mae/Freddie Mac)
Some financial institutions offer unsecured home loans. Unsecured loans don’t require collateral, not even the house. However, while an unsecured loan may sound appealing to the homebuyer, qualifying for one is often very difficult, and the borrower may end up paying more in the long run. Without the security offered by collateral, the debtor’s eligibility and interest rates are more heavily influenced by their credit score. Rates can be anywhere between 5% and 35% APR and are typically scheduled to be repaid over the span of years at a time.
If the borrower defaults on an unsecured loan, the lender is unable to claim rights to the home. The lack of rights to the home means that even if the lender decides to sue, the borrower has less risk of losing their home if they default. However, the underwriting standard for unsecured loans is much more detailed than a secured loan, and the borrower may need near-perfect credit to qualify. Additionally, unsecured loans typically have shorter terms and higher monthly payments.
Open-end credit is commonly referred to as revolving lines of credit, and are structured as a pre-approved lending limit with no fixed time for it to end or lapse. Borrowers are free to repay the balance before the payments are due, and are generally much smaller than closed-end loans. In the US, closed-end mortgages are much more common.
HELOC (Home Equity Line of Credit)
If a borrower has owned a home for some time, chances are they’ve built up a good amount of equity by making mortgage payments. A HELOC is similar to a mortgage in that the debtor’s house is held as collateral, but the payments are installed as a line of credit with the house’s net value tied to the lendable amount. An appraisal and an existing down payment on the house (or how much was lent on a line of credit initially) is required to be eligible for a HELOC.
Compared to closed-ended loans, an open-ended loan offers the borrower a major advantage: flexibility. However, an open-ended loan is typically provided on an adjustable-rate basis, so borrowing against a line of credit can be risky. If the interest rate increases after the borrower takes out the loan, they may owe more than they expected, making repayment difficult.
Bluepoint is Your Resource for Mortgages
At Bluepoint Mortgage, our aim is to make the mortgage loan process as simple and streamlined as possible for our brokers, which in turn will simplify the borrower’s experience. We provide our brokers with the means for several types of loans, including VA, FHA, conventional loans, and reverse mortgages. Learn more about our mortgage loan products or contact us today!