Recent inflation has had a tremendous impact on thousands of household budgets across Canada. However, higher food and gas prices are the least to worry about for some consumers who either bought a new home or refinanced at peak pandemic conditions.
The Bank of Canada has taken to rapidly increasing interest rates to help curb inflationary pressures. But if you are a borrower that has a variable-rate mortgage with a fixed payment, you may be close to hitting your trigger rate which may subsequently cause your monthly mortgage payment to go up.
Many lending experts are concerned that if interest rates continue to increase, nearly 750,000 borrowers could also be stuck paying higher mortgage payments1. As a result, this could put more pressure on the economy by forcing borrowers to slash spending even more.
Nevertheless, if you are in fact a borrower that has a variable-rate mortgage, don’t panic just yet. You will have a few different choices to deal with reaching your trigger rate. Let’s take a closer look at how trigger rates work and how to manage them.
What is a Trigger Rate?
Few borrowers with variable-rate mortgages may know what a trigger rate entails. A trigger rate refers to the interest rate that lenders can increase a mortgage holder's monthly payment, even if it would normally be fixed.
As the central bank increases interest rates, lenders adjust mortgage rates to shifts in the market benchmark. Variable-rate mortgages are pegged to these benchmarks, which means if you have a variable-rate mortgage, your payment can be subject to change.
However, some borrowers opt for a variable-rate mortgage with a fixed payment. Similarly, these loans are subject to adjustment based on fluctuations in the benchmark interest rate.
However, rather than increase your monthly mortgage payment when interest rates rise, lenders reallocate how much of your payment goes towards interest rather than the principal balance of your loan.
Normally small interest rate adjustments aren’t a major issue, but the sharp increase to the benchmark interest rate has left several borrowers in the situation where reallocating their payment would result in no amount going towards principal. In fact, the new rate wouldn’t even be enough to cover the interest.
Since Canadian lending rules don’t typically allow negative amortization, borrowers hitting their trigger rate will need to choose from a handful of options once hitting this threshold.
Recent data from the Bank of Canada indicates that at the end of 2021 roughly a third of homeowners that had a mortgage had a variable interest rate. Of those borrowers, 80% had fixed payments2.
What Are Your Options if You Hit Your Trigger Rate?
If you are a borrower with a variable-rate mortgage that has a fixed monthly payment and you are expected to hit your trigger rate, don’t panic.
Your lender should be reaching out to you to discuss a few different choices to deal with your rate adjustments. A few different options include3:
1. Changing Your Payment
The first option to deal with hitting your trigger rate is to simply change your monthly mortgage payment so that at least some portion is going toward reducing your principal balance. This could mean extending the term of your loan if you have room to do so. If you can’t extend your loan term, increasing your fixed payment amount could also work.
2. Make a Prepayment
Since your trigger rate is partially calculated by how much money you owe on your mortgage, making a one-time lump sum payment could be a variable option to help push your trigger rate higher.
Keep in mind that some lenders may have special rules for how many additional payments you can make and how they are applied to your loan. Make sure you review your mortgage documentation to see if this is permissible.
3. Switch to a Fixed-Rate Mortgage
If you're really in a bind, your mortgage lender may permit you to switch your loan to a fixed-rate mortgage. While this is certainly an option, the downside is that your monthly mortgage payment will probably still go up. Also, note your rate will be locked in based on current market rates which could wind up costing you more money over time.
4. Payoff Your Mortgage
Lastly, you always have the option to pay your mortgage off in full to avoid your trigger rate. However, depending on your loan balance this may not be an option for most borrowers. Even if you have the means, consider the impact tapping into your cash reserves may have on your current budget and future financial goals.
As Canada continues to try to manage the economic impacts of inflation, thousands of homeowners might soon see their monthly mortgage payments spike.
Those borrowers that chose variable-rate mortgages with a fixed monthly payment might soon hit their trigger rate if rate increases continue.
But while hitting your trigger rate isn’t ideal, rest assured there are still a variety of options that can help manage changes to your mortgage.
Adjusting your monthly payment, prepaying, or even modifying your loan to be a fixed-rate mortgage could all be ways to address your trigger rate without breaking your budget.
1 STOREYS. (2022, August 29). 750,000 Canadian Mortgages at Risk of Rising Trigger Rate Payments This Fall. Retrieved October 3, 2022, from https://storeys.com/750000-canadian-mortgages-at-risk-of-rising-trigger-rate-payments-this-fall/
2 Alini, E. (2022, July 27). What is your mortgage trigger rate? This calculator helps you estimate it. The Globe and Mail. Retrieved October 3, 2022, from https://www.theglobeandmail.com/investing/personal-finance/household-finances/article-calculate-mortgage-trigger-rate/
3 Choi, B. (2022, September 7). What is your trigger rate, and how does it affect your variable-rate mortgage? MoneyWise Canada. Retrieved October 3, 2022, from https://moneywise.ca/investing/mortgage-trigger-rates#:%7E:text=Generally%20speaking%2C%20the%20trigger%20rate,mortgage%20in%20January%20for%201.5%25