For homeowners with variable-rate mortgages (VRMs) or adjustable-rate mortgages (ARMs), interest rates can make you feel like you’re on a roller coaster.
For VRMs in particular, your monthly mortgage payment can rise and fall with the tides of Canada’s prime interest rate – which can inherently cause chaos in your budget.
ARMs, in contrast, are slightly more stable when Canada’s prime interest rate fluctuates. This is because while the mortgage’s interest rate floats, your monthly payments are locked in, and so, are more consistent. This can make budgeting much simpler for homeowners.
However, when mortgage rates rise too high, too quickly (like they have recently) the rigid payment schedule and floating interest rate causes ARMs to hit what’s called a trigger rate.
Trigger rates can have far-reaching effects on your budget as a homeowner in Canada.
What is a trigger rate in mortgages?
Trigger rate is the interest rate at which adjustable-rate mortgage (ARM) payments have to rise to meet the higher interest rate.
When interest rates rise too quickly, ARMs hit a point when standardized payments are only covering the interest on the loan – or worse, payments aren’t even covering the interest.
To account for this, banks must change the monthly mortgage payment amount.
How are trigger rates calculated in Canada?
Depending on the bank your loan is from, the exact calculation for a mortgage’s trigger rate varies.
However, trigger rates typically follow a simple equation like:
(Payment amount X number of payments per year / Balance owing) X 100 = Trigger rate in %
So, if you have an outstanding mortgage of $400,000 with monthly payments (12 per year) of $2500, the calculation would look like:
($2500 X 12 / $400,000) X 100 = 7.5%
In this case, your trigger rate would be about 7.5%.
Keep in mind that each bank calculates trigger rates differently. So, if you want your exact number, you should contact your lender.
What happens when you hit your trigger rate?
When your mortgage hits your trigger rate, your lender will contact you. They will go over your options to make sure your payments are keeping up with the interest charged on your mortgage.
Generally, your bank will talk you through options like:
Adjusting your payment - one of the easiest options is to change your payments so that at least some goes toward the principal owing. Options include moving from a 20-year amortization loan to a 25-year amortization loan, or simply increasing your monthly payments.
Making a prepayment - Trigger rates are calculated based on the remaining balance of your mortgage, so making a lump-sum pre-payment to lower the principal increases your trigger rate. Keep in mind that your mortgage will have rules around how much you can pre-pay before facing penalties, so contact your lender to find out if this is a good option for you.
Switching to a fixed-rate mortgage - Depending on your lender, you may be able to move to a fixed-rate mortgage without penalties. This will ensure your payment won’t change in the coming years. However, because this is the most stable payment option it will cost you more in the long term. It will also increase your monthly payments.
Paying off your mortgage - The final option for dealing with trigger rates is to simply pay off your mortgage, though this may come with penalties, depending on your mortgage and your broker. It is also prohibitively expensive for many people.
Do I need to worry about trigger rates in Canada?
Only homeowners with an ARM need to consider trigger rates (floating interest rate + defined payments = trigger rate).
If you have a VRM, your payment will change with Canada’s prime interest rate. That means you won’t have to worry about a trigger rate.
If you have a fixed-rate mortgage, both your insurance rate and your payments will stay the same throughout your mortgage term, regardless of what Canada’s interest rate does.