What Is a Trigger Rate – and How Does It Impact Your Mortgage?
As inflation continues to rise in Canada, the Bank of Canada (BoC) has been raising interest rates to get things back under control. Many Canadians are feeling the impact of this increase on their day-to-day finances, especially those with variable-rate mortgages. Before we discuss the trigger rate and how it impacts your mortgage, let’s discuss the difference between the two types of variable-rate mortgages. Adjustable-rate mortgage (ARM) and variable-rate mortgage (VRM). They both sound very similar but there is a key difference to be aware of.
If you are on an Adjustable-rate mortgage (ARM), your mortgage payment will increase or decrease as the prime rate goes up. If you saw your payment go up for the last few rate increases, this is the type of mortgage you have. On the other hand, with a variable rate mortgage (VRM), your regular payment does not change when the prime rate changes. However, the portion of the mortgage that goes to interest and principal changes. For example, if you have a mortgage payment of $3,500 and $2,000 goes towards the principal, and $1,500 goes towards interest, if rates went up, your payment would still stay $3,500 with a VRM. However, only $500 might now go toward the principal and $3,000 towards interest.
What is Trigger Rate?
The trigger rate applies to variable-rate mortgage holders that are on a fixed payment schedule. In the case of a variable rate mortgage (VRM), the trigger rate is the rate at which the regular mortgage payments no longer cover the accrued interest. Interest rates for the variable rate mortgage have increased so much that the entire payment is dedicated towards the interest only and nothing goes towards the principal. If rates were to increase anymore, the payments no longer cover the interest. While frustrating, the trigger rate is in place to protect homeowners from paying off their mortgages. It ensures homeowners are always making the necessary payments to build home equity.
What You Can Do When You Hit Your Trigger Rate?
When you reach your trigger rate, your lender will contact you with a few different options, so you don’t have negative equity with your payments. Generally, you’ll have the following choices available:
- Increase your payment– This is the simplest option. Your payment will need to be changed, so at least some of it is going toward your principal. For example, if you were on a 25-year amortization schedule when you hit your trigger rate, your financial institution may advise switching to a 30-year amortization. This is a good option for those who already have equity in their home. If you’re already at the maximum amortization allowed, the lender would need to increase your monthly payment.
- Switch to a fixed-rate mortgage– Most lenders allow you to switch from a variable-rate mortgage to a fixed-rate mortgage. By doing this, you’ll lock in at current rates. While this strategy may give you peace of mind for the term of the mortgage, it could cost you more in the long run. Plus, your monthly payments would increase.
- Make a one-time lump-sum payment– The trigger is dependent on the remaining balance of your mortgage. If you make a lump sum payment, that will push your trigger rate higher. Lump-sums go entirely toward your principal, so this could be effective, albeit temporary, solution to avoid your trigger rate.
- Pay off your mortgage– One final option you have to avoid your trigger rate is to pay off your mortgage balance. Of course, if you’re worried about your trigger rate, the odds are you don’t have enough cash lying around to discharge your mortgage.