If you have a variable-rate mortgage, it's important to understand how trigger rates work and how they can affect your mortgage payments. Real estate owners should be aware that when the Bank of Canada raises or lowers interest rates, the amount they owe on their mortgage may change even if their payments remain the same.
How are your mortgage rates calculated?
The Bank of Canada sets the policy interest rate, the rate at which it loans money to banks and other institutions. Each bank then calculates its prime rate, the base rate at which it loans money. If you have a mortgage with variable rates, your interest rate is based on the prime rate.
Therefore, the interest rate on your variable-rate mortgage will change as the Bank of Canada raises or lowers its policy rate.
What is a trigger rate?
In a variable-rate mortgage with fixed payments, your monthly payment goes towards paying off your mortgage principal and your bank's interest. As rates increase, the share of your monthly payment towards your mortgage principal decreases. Your trigger rate is the interest rate at which you are no longer paying any money towards your mortgage principal and are only paying off the bank's interest. Once your mortgage interest rate rises past the trigger rate, your monthly payment is no longer enough to cover interest payments, and you are no longer building any equity.
At this point, your mortgage lender may contact you and encourage you to adjust your payment. While you are not contractually obligated to do so until you reach your trigger point, keeping your monthly payments the same may be financially dangerous.
Any interest you cannot pay with your monthly payments becomes "deferred interest" and is added to the total amount you owe. Then further interest is compounded on that total amount. This means that even though you are making payments, your amount owed keeps increasing every month. If you do not adjust your monthly payments, your balance may rise until it reaches your trigger point.
What is a trigger point?
The trigger point is when your mortgage contract obligates you to change your monthly payment. The exact trigger point of your variable-rate mortgage will be specified in your mortgage contract, but a common trigger point in Canadian mortgages is the moment when your current balance owed is larger than the amount that you borrowed in the first place.
When you reach your trigger point, your lender will contact you to discuss options and set a deadline. You will then be obligated to take action to begin paying down your balance. Your lender may present options like increased payments, paying a lump sum, or converting to a fixed-rate mortgage.
What should you do?
Check your mortgage contract if unsure what your trigger rates and trigger point are. You can also get in touch with your mortgage lender and ask them.
Increasing your monthly payments may be good if you are at or near your trigger rate. If you are near your trigger point and financially unable to increase payments, you may be able to contact your mortgage lender and refinance in a more affordable way.