If you’re someone who makes fixed payments on your variable-rate mortgage or loan, it’s important to understand what the trigger rate is and how it can affect your payments. Keep reading for the full breakdown.
Approximately one-third of Canadian homeowners with mortgages have variable-rate mortgages. The trend toward variable-rate (versus fixed-rate) mortgages is increasing, up 10 per cent since 2019, according to the Bank of Canada. About 75 per cent of these mortgages have fixed payments, which means that the monthly payment is calculated at the beginning of the mortgage term and does not change even if interest rates change. Instead, the amount of your mortgage payment that goes toward interest is adjusted, with the remaining of your fixed payment going toward the principal. However, borrowers can be hit with unexpected costs when interest rates increase beyond what’s called the trigger rate.
What is a trigger rate?
The trigger rate is the point at which the interest rate on your mortgage has increased to the point where your fixed monthly payment is only covering interest and not any of the mortgage’s principal balance. The Bank of Canada estimated at the end of 2022 that for those with a variable-rate, fixed-payment mortgage, “about 50 per cent — or nearly 13 per cent of all Canadian mortgages — have already reached their trigger rate.”
If interest rates exceed that trigger rate — that is, your fixed payments are no longer enough to cover the interest on your mortgage — you may need to increase your mortgage to cover that additional interest. Your lender will be able to tell you exactly what your trigger rate is, but you can also calculate it with the following formula:
(Your mortgage payment amount x number of payments made per year) ÷ (Balance remaining on your mortgage) x 100 = Trigger rate, expressed as a percentage
What is prime rate?
The prime rate, or the prime lending rate, is the interest rate banks and other lenders use to set interest rates on various types of loans. The prime rate controls interest rates, and if prime increases, the interest you must pay on your mortgage will increase along with it. The prime rate is informed by the Bank of Canada’s policy interest rate or target overnight rate. Essentially, when banks and lenders borrow from the Bank of Canada (Canada’s central bank), they’re subject to the policy interest rate. So, when that increases, banks and lenders increase their own rates.
In an effort to curb the record-high rate of inflation, the Bank of Canada increased its policy interest rate in December 2022 by 0.50%. This increase caused the prime rate to also increase, from 5.95% to 6.45%. Prime has been steadily increasing over the past few years, from 2.95% in March 2020, to 3.75% in March 2022, and then to 6.45%, the highest it’s been since 2001. Many estimate that the prime rate will continue to rise in 2023 to match the Bank of Canada’s rate increases.
What does the increase in prime rate mean for me?
Interest rate hikes ultimately mean that any type of borrowing — mortgages, small business loans, or financing for a new vehicle — is more expensive for Canadians. For those borrowers with variable-rate, fixed-payment mortgages or mortgages up for refinancing, this could mean that mortgage payments will need to increase. And again, that’s because if the trigger rate is reached, your fixed-mortgage payments are no longer enough to cover the interest on your mortgage.
The Bank of Canada notes that Canadians who “took on a 30-year mortgage during the COVID‑19 pandemic when variable rates were extremely low will generally see a larger increase in mortgage payments,” which could be as much as a 20 per cent increase.
What are my options if I reach the trigger rate?
There are a few options available to you if the trigger rate is reached on your mortgage. “If you reach your trigger rate or are concerned about your variable-rate mortgage, your Westoba Financial Consultant can provide personalized advice and guidance to ensure you are paying down your mortgage or loan the way you want to,” explains Tracy Houck, Financial Consultant at Westoba.
Adjust payments
Some borrowers may opt to simply increase monthly mortgage payments to cover the interest on their mortgage. This could mean that your mortgage payment will continue to increase as interest rates hike, which could amount to some unexpected costs.
Depending on how much is left on your mortgage, you may opt to make a lump-sum payment; however, that could push your trigger rate higher.
You could also choose to increase the number of payments you’re making on your mortgage. As with any major financial decision, it’s important to chat with your lender or financial advisor about this option, as there may be restrictions on how many additional payments you can make.
Mortgage rate lock
Another option is to lock in your current mortgage interest rate for a specified period of time (anywhere from 30 days to 120 days), essentially guaranteeing that rate. Your lender must approve you for a mortgage rate lock. You also need to be aware of the risk of interest rates dropping during that period — that is, you’re protected from increased interest rates but also won’t be able to take advantage of lowered interest rates during that time.
Refinance mortgage
Refinancing your mortgage means that you are paying off your current mortgage with a new one. Refinancing to convert to a fixed-rate mortgage could be an excellent option to avoid increasing interest rate hikes. There is the chance that interest rates could drop, meaning you might want to consider refinancing again. Refinancing involves an application process, including fees, so it’s important to consider whether the resulting fees are worth the change in your mortgage interest rate.
Speaking with a knowledgeable financial advisor is your best bet for managing the effects of increased interest rates and their effect on your trigger rate. If you haven’t yet met with one of the members of our Mortgage Specialist Team, you can reach out to set up an appointment. We’re here to walk you through your options so that you can choose the best option for your situation and financial goals. Peace of mind is just a click away!
