The Bank of Canada has been raising interest rates to manage inflation and increasing prices of consumer goods. As a result of these actions, the rates offered by most lenders have more than doubled, from 2.45%-5.45%. This dramatic increase has borrowers concerned about reaching their “trigger rate.”
This isn’t as much of a problem if you have a fixed-rate mortgage as nothing will change in your situation until it’s time for you to renew your mortgage. However, if you have a variable-rate mortgage, these interest rate increases could have a direct impact on your cash flow as your monthly payments are likely to increase significantly. Although not all variable-rate mortgage holders will be affected there are ways you can find out whether you’re reaching your trigger rate or not.
What is the trigger rate?
The trigger rate of your mortgage can be defined as the point at which your regular payment is not enough to pay all of the interest accumulated since your last payment. In simple terms, the entirety of your mortgage payment can only cover the interest and not the principal amount. When you reach your trigger rate, what’s being “triggered” is an increase in the balance owed.
Given that your regular payment can no longer cover the cost of borrowing, this payment is now applied to interest. Any amount still owed, is classified as deferred interest and added to your balance to be paid sometime in the future.
How does mortgage trigger rate work?
Each mortgage payment is comprised of two parts: the principal and interest. The principal is the part of your payment that goes toward your balance owed, whereas the interest rate can be defined as the bank’s fee for letting you use their money.
With a variable rate mortgage, your interest rate is closely related to the rate you negotiated with your lender. Moreover, the prime rate on your mortgage is set by the Bank of Canada and banks and lenders set their lending rates accordingly. As such, if the prime rate increases so will the rate on your variable rate mortgage.
Lenders offer variable-rate mortgages with set payment amounts, rather than changing the size of your payment each time the prime rate increases. However, as your mortgage rate rises a larger portion of your payment is put towards interest. As such, the trigger rate is the point at which your monthly payments can no longer pay the interest accrued since your last payment.
What happens when I reach my trigger rate?
Ordinarily, if you’ve reached your trigger rate your bank or lender will inform you that your payments are no longer sufficient to pay down your mortgage. They will also provide you with a few options to make sure you don’t have negative equity with your payments. However, banks and lenders have specific solutions that they use to maintain equity in your home. As a result, your options may vary from one lender to the next.
Although, in general these are some of the common solutions offered by banks and lenders:
- Adjust your payment: When you reach your trigger rate your payment will need to be adjusted so at least some of your monthly payment is going towards your principal. Depending on your bank or lender this will either be done for you, or they will ask you to make the change yourself. This can be done by extending your amortization or even increasing the size of your monthly payments.
- Switch to a fixed-rate mortgage: Your lender might allow you to convert to a fixed-rate mortgage without any penalties. However, this may change from one lender to another. Doing so will let you pay off your mortgage at the current rate. Although this can be more costly in the long run and your monthly payments would increase.
- Pay off your mortgage completely: Provided you have the funds; you can opt to pay off your mortgage balance completely. However not everyone has ready access to such large amounts, even more so when they’re worried about hitting their trigger rate.
How do you calculate variable mortgage trigger rate?
For the most reliable estimate, it’s probably best to consult with your financial advisor or lender. This is because only they understand your financial situation specifically. Although you can use the following steps to try to make your own calculations if you wish:
- Gauge the amount you are charged for each mortgage payment
- Check the number of payments you need to make in a year (bi-weekly, monthly)
- Double check to see whether there’s still an outstanding amount that hasn’t been paid.
The moment you have verified all of this information, you can make your calculation based on this formula:
(Payment Amount x Number of Payments per year/Balance owing) x 100 = Trigger Rate in %
- Multiply your payment amount by the number of payments per year.
- Divide that amount by the balance owed on your mortgage.
- Multiply that amount by 100.
For example, if you have a mortgage balance of $500,000 with bi-weekly payments (26 per year) of $1,100. This is what the formula would look like:
($1,100 X 26/ $500,000) X 100= 5.72%
In this case you trigger rate would be 5.72% so essentially in the event your variable mortgage rate increases to 5.72% you will have hit your trigger rate.
Refinance your mortgage with Mortgage Maestro
Sometimes, even the options listed above may not be enough to cope with the trigger rate on your mortgage. In this case, refinancing your mortgage can be a viable solution. Mortgage Maestro offers mortgage refinancing services where you can get your current mortgage refinanced at a different rate.
Refinancing will allow you to manage your mortgage payments if you’ve reached your trigger rate, or even avoid reaching it altogether. We offer competitive rates from multiple lenders and unbiased customer-focused financial advice.
Contact us today and we’ll have an experienced mortgage professional assigned to you immediately.