This piece was originally published on September 26, 2022, and was updated on January 31, 2023.
As inflation continues to send prices higher, the Bank of Canada (BoC) has been raising interest rates in an effort to get things back under control. Since the Bank carried out a successive series of rate hikes from March 2022 to January 2023, the prime rates of most lenders have nearly tripled, from 2.45% to 6.70%. This dramatic leap has prompted public concern about mortgage borrowers reaching their “trigger rate.”
If you have a fixed-rate mortgage, nothing will change for you until it’s time to renew. But if you have a variable-rate mortgage, these rate hikes have a direct and immediate effect – and you could be at risk of reaching your trigger rate. Not all variable-rate mortgage holders have to worry about trigger rates, however. Read on to learn about whether you might be affected, and what to do if you are.
A tale of two triggers
There are actually two triggers at risk of being pulled: your trigger rate and your trigger point. To understand these terms, we need to first take a look at how variable-rate mortgages work.
Each mortgage payment is made up of two parts: principal and interest. The principal is the portion of your payment that goes toward your balance owing, while interest is the bank’s fee for letting you use their money.
When you have a variable-rate mortgage, your interest rate is defined relative to your lender’s prime rate. For example, your mortgage rate might be something along the lines of prime minus 1.20%. When the prime rate goes up, your mortgage rate goes up along with it - increasing the amount of interest you need to pay each month.
To help keep things predictable, many lenders offer variable-rate mortgages with fixed payments. Instead of changing the size of your payment every time the prime rate changes, your lender will continue to collect the same amount and allocate a larger or smaller portion of your payment to interest.
If you have a variable-rate mortgage with adjustable payments, you have nothing to worry about. But if your variable-rate mortgage has fixed payments, rising interest rates can cause trouble. As your mortgage rate rises, a larger portion of your payment is put toward interest and a smaller portion of your payment goes toward principal. The trade-off for not increasing your payment is that it will take longer to pay off your mortgage.
What is the trigger rate?
Your trigger rate is the point at which your regular payment is no longer enough to pay all of the interest you’ve accrued since your last payment. In other words, your entire mortgage payment is going to interest and none of it is going to your principal. This is the first of two triggers you can reach. If you've hit your trigger rate, you're not alone - back in November 2022, the Bank of Canada estimated that about half of variable-rate mortgage holders with fixed payments had hit their trigger rate.
When you reach your trigger rate, what’s actually being “triggered” is an increase to your balance owing. Because your regular payment is no longer enough to cover the cost of borrowing, the entire payment is applied to interest. Any amount still owing is termed deferred interest and added to your balance to be paid sometime down the road.
When you’ve reached your trigger rate, you’ve stopped paying off your mortgage and started borrowing more. Those in the know call this “negative amortization.”
What happens when I reach my trigger rate?
While no intervention is necessary when you reach your trigger rate, your lender or mortgage broker will likely give you a courtesy call to let you know your payments are no longer big enough to pay down your mortgage. They’ll explain your options and help you reach an informed decision about how to proceed.
Just because you can carry on with the same monthly payment you’ve been making, however, that doesn’t mean you should. With every month that passes, you’ll owe more and more money on your home. Your rising balance will demand a rising interest payment, making the problem worse as time goes on.
If it’s at all possible, increase the size of your monthly mortgage payment well before you reach your trigger rate. Otherwise, you risk reaching an even worse threshold: your trigger point.
What is the trigger point?
Your trigger point is the time at which you can no longer carry on with the same monthly payment you’ve been making.
There isn’t a single overarching rule that defines the trigger point. Rather, your trigger point will be spelled out in your mortgage contract.
A common trigger point is the time when the balance owing on your mortgage exceeds the amount you borrowed in the first place. For example, if you took out a $500,000 variable-rate mortgage and reached your trigger rate after paying the balance down to $490,000, the interest amount your payment didn’t cover would start being added back to your balance. You would reach your trigger point if and when your balance got back up to $500,000.
Your trigger point could also be described as a percentage of your property’s value. For example, you could reach your trigger point when your mortgage balance exceeds 100% of your home’s appraised value.
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What happens when I reach my trigger point?
When you reach your trigger point, you will be forced to take action to start paying down your balance. Your lender will contact you to discuss your options and set a deadline to remedy the situation.
Your options may include one or more of these:
- Increase your monthly payments: The simplest option, although not necessarily the easiest to achieve, is to increase your regular payment to get back on track. The requirements vary by lender but your minimum payment will need to at least cover your interest cost with some room left over to pay down your principal. You may be required to resize your payment to get back on track for your original amortization schedule. Use a mortgage payment calculator to estimate how much you might have to pay.
- Make a lump-sum payment: If you have cash lying around, you can make a lump-sum payment to lower your mortgage balance. This one-time payment will bring you back under your trigger point but will only be a temporary fix if you don’t increase your payments.
- Convert to a fixed-rate mortgage: Most lenders allow customers to switch from a variable-rate mortgage to a fixed-rate mortgage at any time. Fixed mortgage rates tend to be higher than variable mortgage rates, but they’re guaranteed to stay the same for a term of up to 5 years. Making this change will almost definitely increase your monthly payments, but can help you avoid more surprises, at least for the remainder of your term.
- Extend your amortization: In conjunction with raising your regular payment, you may be able to extend your amortization period to keep your payments manageable. Keep in mind that the longer you take to pay off your mortgage, the more interest you’ll end up paying. Extending a $100,000 mortgage from 5 years to 10 years at 4.25% costs an extra $11,747 in interest. Refinancing may also lead to penalties (the penalty for breaking a variable-rate mortgage is typically three months’ simple interest), and will require the services of a real estate lawyer.
What should I do if I’m concerned about reaching my trigger rate?
As interest rates rise, it’s best to take action sooner rather than later. It’s a lot easier to keep your mortgage on track now than it will be to get it back on track after reaching your trigger rate.
The first thing to consider is increasing your regular mortgage payment before you reach your trigger rate (the point at which your payment isn’t enough to cover the cost of borrowing). If you can afford it, this is the best way to ensure you’ll continue to make progress in paying off your mortgage. Staying at or under your trigger rate is also the only way to avoid reaching your trigger point.
You may also want to think about converting to a fixed-rate mortgage. While it will likely mean higher payments, it will also bring some stability back to your monthly budget and prevent you from finding yourself back in the same situation.
What should I do if I’m concerned about reaching my trigger point?
If you’re at or near your trigger point (the point at which your lender demands a higher payment), you’re in hot water. This means you’re not making any progress at all toward paying off your mortgage, and may be racking up debt from deferred interest payments faster than you realize.
If you’re unable to make a bigger payment, it’s time to talk to your lender or mortgage broker about your options. You may be able to refinance your home in a way that’s more affordable, convert to a fixed-rate mortgage, or make a lump-sum payment to bring down your balance.
The bottom line
Rising interest rates have a real effect on variable-rate mortgages that could have lasting implications for your financial health. Check in with your lender or mortgage broker to ensure you’re paying down your mortgage the way you want to, and if you can, don’t hesitate to increase your regular payments to stay ahead of rising rates.