Over the past year or so, general prices have gone up in Canada due to inflation. To balance that effect, the Bank of Canada (BoC) has raised its prime interest rates by more than double (from 2.45% to 7.2%). That increase is making it tougher for many borrowers to afford their mortgages, pushing them closer to their “trigger” rate.
This is particularly true if you’re paying a variable interest rate on your mortgage since variable rates change according to the BoC’s prime rates. Keep reading to learn what the trigger rate is and what you can do when you reach yours.
What Is The Trigger Rate?
When your normal fixed mortgage payment on a variable rate mortgage is no longer large enough to cover the interest you’ve accumulated since your previous payment, that’s when you’ve reached your trigger rate. Simply put, all the money you’re investing into your payment only ends up paying down the remaining interest you owe, rather than the mortgage principal itself.
What Does The Trigger Rate Affect?
Once you hit the trigger rate, your balance owing is the thing that’s being “triggered”. Since your original mortgage payment won’t sufficiently cover the cost of borrowing, the amount you’re paying is applied to the interest instead. Anything that you have left to pay is then considered “deferred” interest and added to your future mortgage balance.
What Happens When You Reach Your Trigger Rate?
Once you hit your trigger rate, your mortgage lender or broker will inform you that your payments are no longer large enough to cover your principal. During this call, they’ll also discuss your options and help you find a better way to manage your payments.
How Do You Calculate Your Trigger Rate?
Your trigger rate should be somewhere on your original mortgage contract. That way, you’ll know when to expect a call from your mortgage professional.
For a more accurate calculation of your trigger rate, you can call your lender/broker or use your mortgage amount, monthly payment and interest rate to form this equation:
- (Monthly Payment × Number of Payments Per Year ÷ Balance Owing) × 100 = Trigger Rate Percentage
Here’s an example using the same mortgage numbers as above:
- You have $600,000 remaining on a $650,000 variable-rate mortgage over 20 years.
- You’re also paying $4,981.95 a month, for a total of 12 payments a year
- ($4,981.95 × 12 ÷ $600,000) × 100 = 9.96% trigger rate
Don’t forget that 9.96% would be your estimated trigger rate. Every lender has a slightly different way of calculating trigger rates, so speak with them to get a more exact figure.
What Happens If You Continue Making The Same Payment?
If you continue making the same payment, just remember that:
- The balance owing on your mortgage will go up because your mortgage payments are only able to cover part of the interest.
- As interest accumulates, your outstanding balance will slowly increase as well, which will cause your interest payments to rise too. This could potentially add a significant amount of debt to your total mortgage.
- If you don’t increase your mortgage payment before you hit your trigger rate, you may be in danger of reaching your “trigger point”, which will make things worse.
What Is A Trigger Point?
The trigger point appears in your mortgage contract and indicates the moment when you’re no longer allowed to make the same mortgage payment. This usually occurs when your outstanding mortgage balance outweighs the size of your original loan, but every lender has different rules in this department. Here’s a basic example:
- You borrow $650,000 for a mortgage with a variable interest rate
- Interest goes up, so you hit your trigger rate when what you owe is greater than what you borrowed;
- You’ll reach your trigger point if your balance rises back to $650,000.
- Your remaining interest gets added back to your total mortgage balance
When Do You Reach Your Trigger Point?
Mortgages vary throughout the country, so every borrower with a variable-rate mortgage has a different trigger rate. That said, you’ll normally hit your trigger point once interest rates rise by at least 2% from the time when you initially signed your mortgage contract.
A trigger point can be measured as a percentage too. For instance, if your mortgage balance goes beyond 100% of your home’s appraisal value, you’ll hit your trigger point.
What Can You Do When You Hit Your Trigger Point?
When you reach your trigger rate, your lender may offer you the following choices:
Adjust Your Payment
The easiest option is to raise your mortgage payment so more of it goes to your principal. Although this can help you build equity and pay your balance faster, your minimum payment needs to cover your interest, plus a portion of your principal. That means you’ll need to qualify for an adjustment.
Make A Prepayment
Since your trigger point is based on your outstanding mortgage balance, making an early (lump sum) payment will raise your trigger rate. Just remember that this will only be a temporary solution and that your mortgage contract may only allow a certain number of additional payments.
Pay Off Your Mortgage
While it’s the least affordable option, paying your entire mortgage balance is the best way to avoid reaching your trigger point and save on interest. You can do this by increasing your monthly payments, making early payments or offering a larger down payment when you apply for your mortgage.
Extend Your Amortization
As a more affordable option, you can refinance your mortgage by extending your amortization and lowering the payments. Refinancing can also help lead to lower interest rates if your credit or income situation has bettered since you last applied. However, watch out, because refinancing involves a whole new approval and payment process, which leads to extra costs like penalties and closing costs.
To get the best deal, consider using a mortgage broker like Mortgage Maestro to help you compare rates from various lenders through a single application. This will not only save you time, but you’ll be able to choose a mortgage solution that best meets your needs.
Convert To A Fixed Mortgage
If your variable interest rate is the problem, your lender may let you switch to a fixed-rate mortgage without penalty. Although fixed rates are often higher (which leads to larger payments), they’re guaranteed not to change for mortgage terms of up to 5 years. This can help put your mind at ease.
Are You About To Reach Your Trigger Rate?
Then make sure to contact your mortgage expert immediately and work out a solution. Remember, having a negative amortization is never a good thing, so it’s important to avoid reaching your trigger rate however you can.