In recent years, variable rate mortgages (VRMs) became increasingly popular with borrowers, since they had lower interest rates than fixed-rate mortgages and also generally lower prepayment penalties should the mortgage have an early payout.
The Bank of Canada estimates about three-quarters of variable-rate mortgages have fixed payments. At the end of October 2022, the Bank of Canada estimated 50% of variable rate mortgages had hit their trigger rate with more hitting the trigger rate early in 2023.
However, one factor many borrowers may not be aware of is the potential for their mortgage payment to change due to something called a “trigger rate.”
Let’s take a look at what trigger rates are, and how they can affect your mortgage.
A trigger rate is a predetermined interest rate that is set by the lender when the mortgage is initially taken out. This rate acts as a “ceiling”, meaning that if the mortgage rate increases above this rate, the lender can automatically adjust the mortgage payment to the trigger rate. The trigger rate is typically set at a rate that is higher than the current market rate, so that if the market rate rises, the lender can protect itself from losses.
Variable rate mortgages (fixed payments) unlike adjustable rate mortgages (payments adjust according to the increases or decreases in the lender’s prime lending rate) have trigger rates to ensure homeowners are always building equity with their payments, especially as interest rates rise.
Each lender has a different way to calculate the trigger rate but generally the trigger rate is when your interest payments exceed your total payments and there is no longer a reduction in the amount you owe on your mortgage with your payments only covering the interest charges.
The balance of your mortgage would actually start to potentially increase. At a certain point, you may be required to adjust your payments, make a prepayment, or convert to a fixed rate mortgage.
Some lenders may allow for negative amortization, where the interest payment is permitted to exceed the total mortgage payment. Principal payments are therefore negative, so the balance owed on the mortgage increases from month to month.
The best way to avoid your mortgage trigger rate is to be proactive about your payments and make sure you are aware of how much interest you are paying.
If you can, try to make larger payments to keep ahead of rising interest rates or prepayments when possible so that you can pay off your mortgage faster.
It’s important to understand how trigger rates work before taking out a VRM, as they can have a significant impact on your mortgage payments. Be sure to speak with a qualified mortgage broker to ensure that you understand the terms of your mortgage, including any potential trigger rates.
These rising payments on a fixed payment variable rate mortgage may be unexpected and have an adverse effect on a household’s already tight budget that why being proactive is important. We may see another rate increase again on March 8 which is the next Bank of Canada rate announcement.
If you would like to review the current status of your variable rate mortgage and possible strategies to navigate this rising rate environment, please reach out. You can email me at [email protected] or if you would like to chat, please book a time here on my calendar and we can review possible strategies to keep your mortgage working for you and not vice versa.
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.