Variable Rate Mortgages Are About to Hit Their Trigger Rate

Variable Rate Mortgages Are About to Hit Their Trigger Rate

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The author of this article is Ross Taylor. Ross is a leading expert in the Canadian Mortgage Industry.

Whether you have a variable rate mortgage, fixed rate mortgage, or line of credit, you are a homeowner or soon to be homeowner, this article is worth the read. On September 7th, the Bank of Canada announced it's overnight rate increased by 0.75%, rising the rate to 3.25% from the 0.25% low. What does this all mean for Canadians though? Well the banks have all raised their prime rate by 0.75% as well, up to 5.45% from 2.45% earlier this year. This means if you have a line of credit, variable rate mortgage, your mortgage is up for renewal, or you are looking to buy a home, the cost of all of those things has increased! 

First things first, let's look at variable rate mortgages versus fixed rate mortgages and talk about how they work.

75% of all Canadian mortgages have historically been fixed-rate

This stat makes sense, people are usually risk-averse and choose to lock in a fixed-rate mortgage, so their rate does not fluctuate.

But the lure of a static monthly payment, set at 2% lower interest rates than the fixed rate alternative, converted many fixed rate denizens into joining the variable rate fan club for both new mortgages and refinances and renewals. In a recent informal poll of several top mortgage brokers, they cited anywhere from 35% to 45% of all mortgages they have arranged in the past year have had variable interest rates.

An important concept to highlight is the idea of a static payment variable interest rate mortgage, as Ross describes: 

The customer’s monthly mortgage payment is not meant to fluctuate when the Prime Rate goes up or down over the life of the loan. This payment style was music to many borrowers’ ears.

In other words, the rate can fluctuate, but your payment will remain the same. When rates rise, less of your payment goes towards paying down the principal amount owing and more towards interest. Important to note that not all variable rate mortgages are setup this way. Some are setup to maintain your amortization. Which means that as the rate increases, your payment will increase. Rates going up 3% this year, has dramatically increased payments to these types of mortgages.

Even if you have the static variable rate mortgage payment- you might not be in the clear. This is where the term "trigger rate" comes into play.

If rates move up in an extreme fashion, as we are seeing now with the benchmark rate, there are circumstances where the lender may ask you to increase your mortgage payment.

The chart below shows the changes to the prime rate in 2022 alone.

On Trigger Rates and Trigger Points, Ross does a great job explaining.

If your bank’s Prime Rate ever rose to the point where your personal scheduled mortgage payments are only paying interest and not principal, the bank would say you have exceeded your “Trigger Rate.” If you exceed your personal Trigger Rate, to avoid your mortgage balance owing increasing, the bank will notify you. They typically recommend customers increase the mortgage payment or convert to a fixed rate mortgage to avoid reaching the Trigger Point (defined below). However, no action is required by the customer (and/or cosigner) at this time. When interest rates increase to the point that regular principal and interest payment no longer covers the interest charged, interest is deferred, and the principal balance (total cost) can increase until it hits the Trigger Point.

Ross shares from a colleague a simple calculator (that can be found in the linked article) to determine what your trigger rate may be. You can also review the documentation provided to you in the initial agreement.

We have been in a low rate environment for nearly 10 years, which made variable rate mortgages look very enticing. That is the risk of the variable rate, that rates can go up and we have certainly seen that this year. Never a bad time to touch base with your mortgage professional, your financial advisor to discuss your specific situation so that you can be best prepared.

The article linked and mentioned above was posted in September 2022 and written by Ross Taylor. Check out more from Ross at his website askross.ca.