In recent years, Canadian mortgage holders have faced a rollercoaster of interest rate changes. The Bank of Canada’s (BoC) aggressive rate hikes between March 2022 and July 2023 – intended to combat inflation – led to nearly tripled prime rates. This dramatic shift left many with variable-rate mortgages concerned about hitting their trigger rate or their trigger point.
While the BoC has shifted to rate cuts due to improving inflation, the risk of future hikes remains. Understanding these mortgage triggers is crucial for safeguarding your financial well-being. Let’s delve into the details:
The Two Triggers: Rate vs. Point
1) Trigger Rate: The Tipping Point for Variable-Rate Mortgages
The trigger rate is like a financial threshold for variable-rate mortgages with fixed payments. It’s the specific interest rate at which your monthly payment becomes just enough to cover the interest charges, leaving nothing to chip away at the actual loan amount (the principal).
How it happens?
- Variable-rate mortgages fluctuate with the lender’s prime rate.
- When the prime rate rises, so does your interest payment, even if your overall monthly payment stays the same.
- The excess interest not covered by your payment gets added to your principal, increasing your total debt – this is negative amortization.
The Bank of Canada’s rapid rate hikes in 2022-2023 pushed a substantial number of variable-rate borrowers past this threshold. A February 2023 BoC report projected that up to 80% of those with fixed-payment variable mortgages could potentially reach their trigger rates by the end of 2023, highlighting the widespread impact of rising rates.
2) Trigger Point: When the Alarm Bells Ring
The trigger point is a more serious situation, determined by the terms of your specific mortgage contract. It typically occurs when:
- Balance Exceeds Original Loan: Your outstanding mortgage balance, including any added interest from negative amortization, surpasses the original amount you borrowed.
- Loan-to-Value Ratio (LTV) Threshold: Your mortgage balance exceeds a certain percentage of your home’s appraised value. This percentage is usually 100% but could be higher depending on your contract.
Why Is It Critical?
Hitting the trigger point means your lender is contractually obligated to intervene. They will usually give you a timeframe to take action, which could involve increasing your payments, making a lump-sum payment, or even switching to a fixed-rate mortgage.
Why Variable-Rate Mortgages Are Vulnerable?
Variable-rate mortgages are inherently sensitive to fluctuations in the Bank of Canada’s (BoC) policy rate, as they are tied to the lender’s prime rate. When the BoC raises its policy rate, the prime rate typically follows suit, leading to higher interest costs for variable-rate borrowers.
- Fixed Payments, Changing Allocation: Most variable-rate mortgages in Canada have fixed payments. This means your total monthly payment remains the same, even when interest rates change. However, the allocation of that payment changes. As rates rise, a larger portion goes towards interest, leaving less for the principal.
- Negative Amortization: When the interest portion exceeds your entire payment, you enter negative amortization. The unpaid interest gets added back to your principal, increasing your overall debt. This cycle can continue as long as rates stay high, potentially leading to the trigger point.
- Extended Amortization and Higher Costs: Delayed principal repayment means it takes longer to pay off your mortgage. This translates to a longer amortization period and significantly higher interest costs over the life of the loan.
For Example:
| Scenario | Monthly Payment | Interest Rate | Principal Portion | Interest Portion |
| Initial | $2,000 | 4.00% | $1,200 | $800 |
| Rate Hike | $2,000 | 6.00% | $800 | $1,200 |
| Trigger Rate | $2,000 | 7.50% | $0 | $2,000 |
As the rate increases, less money goes towards the principal, eventually leading to negative amortization at the trigger rate.
Navigating Trigger Rate Challenges
If you’ve hit your trigger rate, don’t panic. It’s a common occurrence during rising-rate environments. The key is to take proactive measures:
- Assess Your Finances: Evaluate your budget to determine if you can increase your monthly payments. Even a small increase can make a significant difference over time.
- Contact Your Lender: Discuss your options. Some lenders offer solutions like temporarily increasing payments or switching to a fixed rate.
- Seek Professional Advice: A financial advisor can help you create a personalized plan to manage your mortgage and finances in a rising-rate environment.
Trigger Point: Time for Action
Reaching your trigger point is a critical juncture that requires immediate attention. Ignoring it can lead to further debt accumulation and potential financial difficulties. There are several options when hitting the trigger point including.
- Increase Payments: Your lender will likely require a significant payment increase to cover the full interest and start reducing the principal again.
- Lump-Sum Payment: If you have available funds, making a lump-sum payment can bring your balance below the trigger point.
- Fixed-Rate Conversion: Switching to a fixed-rate mortgage can provide stability, but often at a higher interest rate.
- Amortization Extension: Extending your amortization period lowers monthly payments, but increases the overall interest paid.
- Refinancing: This involves replacing your current mortgage with a new one, potentially with a lower rate or different terms. However, it may come with fees and closing costs.
Proactive Measures for Mortgage Holders
- Stay Informed: Monitor the Bank of Canada’s announcements and economic news for insights into potential rate changes.
- Financial Stress Test: Ensure you can comfortably handle a mortgage rate increase of 1-2 percentage points.
- Prepayment Privileges: If your mortgage allows prepayments, consider making extra payments when possible to reduce your principal faster.
- Financial Safety Net: Maintain an emergency fund to cover unexpected expenses and potential mortgage payment increases.
The Importance of Professional Guidance from Pegasus
Navigating the complexities of variable-rate mortgages in a rising-rate environment can be daunting. That’s where seeking professional guidance becomes crucial. A trusted mortgage advisor, like Pegasus, can play a pivotal role in helping you understand your options, create a tailored plan based on your unique financial situation, and ultimately make informed decisions to safeguard your financial well-being.
Pegasus Expertise:
- In-depth knowledge: Pegasus team of experts deeply understands the Canadian mortgage landscape and the intricacies of variable-rate mortgages. They stay up-to-date with the latest economic trends, interest rate forecasts, and mortgage product offerings.
- Personalized approach: Pegasus takes the time to understand your individual financial goals, risk tolerance, and budget. They analyze your current mortgage terms and assess your vulnerability to rising rates.
- Tailored solutions: Based on your specific needs, Pegasus can recommend a range of options, such as refinancing, switching to a fixed-rate mortgage, or adjusting your payment schedule. They’ll help you weigh the pros and cons of each choice.
- Ongoing support: Pegasus doesn’t just offer one-time advice. They provide ongoing support throughout the life of your mortgage, helping you adapt to changing market conditions and ensuring you’re always on track to meet your financial objectives.
Whether you’re concerned about hitting your trigger rate, facing a trigger point, or simply want to proactively manage your mortgage in a rising-rate environment, seeking professional guidance from Pegasus can provide invaluable peace of mind and help you make the best decisions for your financial future.
The Bottom Line
Your Mortgage, Your Power: Understanding the nuances of your variable-rate mortgage, especially the trigger rate and trigger point, empowers you to take control of your financial well-being amidst changing interest rates. While the current economic landscape may seem calmer, the potential for future rate fluctuations remains. By proactively monitoring rates, budgeting for potential increases, and seeking expert guidance when needed – particularly from trusted advisors like Pegasus – you can confidently navigate the mortgage market and ensure your homeownership journey remains secure and rewarding. Remember, your mortgage is more than just a financial instrument; it’s a significant investment in your future. By staying informed and taking proactive measures, you can protect that investment and thrive in any interest-rate environment.
