A common concern among homeowners is the impact of rising interest rates on their variable mortgages. As interest rates have remained high, many mortgages have approached their trigger rates and trigger points. 

This post explains trigger rates, how to determine your trigger rate and the potential outcomes for those with variable-rate mortgages.

Key Takeaways

• The trigger rate occurs when the mortgage payment only covers interest, and the principal balance is no longer paid.
• The trigger point occurs when the amount owed on the mortgage exceeds the initial mortgage balance.
• Only variable-rate mortgages (VRMs) with fixed payments can potentially reach their trigger rates and trigger points.

Trigger Rates for Mortgages

The trigger rate is when your mortgage payments solely cover the interest and no principal. This happens when interest rates rise on a variable-rate mortgage without an increase in the mortgage payment. 

When interest rates rise, more mortgage payment is allocated towards paying the interest rather than the principal. Once you’ve hit your trigger rate and are only paying interest, this can lead to negative amortization, where the amortization period for a variable mortgage increases instead of decreases.

Trigger rates are only reached on variable-rate mortgages. You are unaffected if you have an adjustable-rate mortgage or a fixed interest rate. 

How to Determine Your Trigger Rate

The easiest method for determining your trigger rate is to read over your mortgage document and the original agreement you signed with the lender. The trigger rate will be specified in your documents. The trigger rate specified in the mortgage agreement suggests that you have not made any prepayments throughout your term, as any prepayments will impact your trigger rate.

To calculate your trigger rate, you must know your payment amount, frequency (number of payments per year), and the current balance owed. The trigger rate is calculated by multiplying the payment amount by the number of payments and dividing that by the balance owed.

Trigger Rate = (Payment Amount x Number of Payments per Year / Balance Owing) x 100 

The trigger rate would be 5.53%, assuming a biweekly payment of $850 and a remaining balance of $400,000. 

$850 x 26 / $400,000 x 100  = 5.53%

Definition of Trigger Point

If your mortgage reaches the trigger rate, the borrower is not required to take any action. If the trigger rate is surpassed, the amount owed will eventually exceed the original mortgage principal. This is when you’ve reached your trigger point and must take action. Your bank advisor or mortgage professional will reach out to get your mortgage back on schedule. 

You can get your mortgage back on track by either using your prepayment privileges to pay down some of the mortgage principal, increasing your regular mortgage payments to start contributing some of each payment toward the principal or refinancing the mortgage to increase your amortization. 

It’s important to note that the exact dollar amount or loan-to-value (LTV) ratio determining your mortgage’s trigger point may vary based on the lender. 

Impact of Bank of Canada Rate Hikes on Variable Mortgages

The Bank of Canada (BoC) implements monetary policy by changing the policy interest rate to achieve a 2% inflation target. When inflation exceeds this target, the BoC uses higher interest rates to discourage consumer spending and promote savings. 

Lenders raise their prime rates when the Bank of Canada raises the policy interest rate. Prime rates directly affect variable mortgages and other revolving credit products lenders offer. 

When the policy rate increases, those with variable-rate mortgages will immediately be impacted as their interest rate will change. This could result in higher mortgage payments for those with adjustable-rate mortgages (ARMs) or a more significant portion of the mortgage payment going towards interest rather than the principal for those with variable-rate mortgages (VRMs).

Comparison of Variable-Rate Mortgages (VRM) and Adjustable-Rate Mortgages (ARM)

There are 2 types of variable mortgages: those with fixed payments and variable payments. Mortgages with fixed payments and variable interest rates are called variable-rate mortgages (VRM). Mortgages with both variable payments and interest rates are called adjustable-rate mortgages (ARM).

Interest rates on both an ARM and VRM will change with changes to prime rates, but where these mortgages differ is how the change in interest rates is applied. 

With an ARM, the mortgage payment is variable, meaning the principal portion is fixed while the interest portion will be adjusted to account for a higher interest payment. This keeps your amortization on schedule since you continue to make regular principal payments, and your mortgage is not at risk of reaching the trigger rate or trigger point. However, you risk immediate payment shock as your mortgage payments fluctuate with any changes to interest rates. 

With a VRM, the mortgage payment remains fixed, so when interest rates increase, the proportion of the payment going to principal and interest will adjust to account for a higher interest payment. If interest rates rise, more of your payment will go toward interest and less toward principal. When interest rates decrease, a larger portion of your payment will be allocated to the principal balance. VRMs are at risk of reaching the trigger rate or trigger point, which could delay payment shock for borrowers. 

Trigger Point Example

If you chose a variable-rate mortgage (VRM) when interest rates hit record lows, you likely reached your trigger rate and may have already hit your trigger point. 

For example, if you have a VRM of $400,000 at 2.45% with a 25-year amortization and a 5-year term, your original mortgage payments would have been approximately $850. Once interest rates reach 5.53%, you will have hit your trigger rate. 

If today’s 5-year variable interest rate is 6.94%, you have surpassed your trigger rate. If your lender allows negative amortization, your mortgage balance will increase until it is more than the original amount borrowed. 

The Impact of Interest Rate Hikes on Monthly Budgets

As we have witnessed, significantly rising interest rates can impact your finances and budget. When you reach your trigger rate or trigger point, your lender may require you to take action, which can further strain your finances. In such situations, it is essential to reevaluate your expenses and make adjustments where possible to make room in your budget.

It may be possible to mitigate a rise in monthly payments by increasing your earnings, but this may only sometimes be a feasible or immediate solution that you can utilize. To take more immediate steps, you should examine how to cut costs in other parts of your budget to allocate more funds towards your mortgage payments.

Additional alternatives include liquidating assets or utilizing your emergency savings. If interest rates have risen to the extent that you are having trouble keeping up, it may be necessary to sell the property.

How to Avoid Hitting Your Trigger Rate or Trigger Point

Switching from a variable-rate to a fixed-rate mortgage is one option to help when interest rates increase. This could help you maintain a budget by providing a consistent payment and interest rate for the remaining term, allowing you to ride out any further rate increases.

Another option is to make a prepayment toward the principal amount. If your lender permits it, you can make multiple smaller lump sum payments when you have extra savings. You can also increase the amount of your regular mortgage payment. Most lenders offer the flexibility to do this at least once a year. This extra payment will go towards reducing the principal amount of your mortgage.

Switching some of the mortgage to a fixed rate option is possible for those with a collateral charge mortgage that allows multiple components. This option has a partial penalty, you won’t need to re-qualify, and it reduces your risk. You may incur a prepayment penalty for breaking the mortgage components not up for renewal if they have a different maturity date. All components under your collateral charge must be transferred when you switch to a new lender and the mortgage is discharged from your current lender.

Frequently Asked Questions

Final Thoughts 

Utilizing eligible tax deductions on mortgage interest can help offset taxes at tax time. Each person’s situation and taxes are unique, so the eligibility and regulations for deducting mortgage interest may vary. Seek advice from a certified tax professional to ensure you take full advantage of all eligible tax deductions. 

If you’re ready for mortgage advice, contact our mortgage professionals to help you develop a mortgage plan that aligns with your investment goals.