The Bank of Canada has increased the Prime Rate several times over 2022 causing many Canadians with Variable Rate Mortgages to wonder if, and when, it could potentially affect them and their repayment plans. In addition, these impacts on variable rates have caused a flurry of headlines referencing “trigger rates”—the rate at which your monthly payment no longer covers accrued interest on the principal outstanding for that monthly payment period. To help simplify this concept, and offer advice on what you should do if your trigger rate has been reach, we’ve put together this quick FAQ guide.
What is a trigger rate?
Whenever you make a mortgage payment, a portion goes towards paying down the principal, the amount of money you’ve borrowed and are required to pay back. Another portion of your payment goes toward the interest, the percentage amount regularly charged to you by your lender as part of your mortgage agreement.
When you have a variable rate mortgage, the amount you pay towards the principal versus what you pay towards the interest can change, depending on whether the prime rate (the baseline interest rate a financial institution uses for every loan) has increased or decreased. When the prime rate decreases, more of your payment goes towards the principal, whereas more of your payment will go towards interest, if the prime rate increases.
The term trigger rate describes the point when the interest rate on your variable rate mortgage has increased so much that your payments are not enough to cover the interest that accrues between payments and is no longer paying down any of the principal.
What types of mortgages are impacted by trigger rates?
Trigger rates impact variable rate mortgages. It’s important to call out here that there are two types of variable mortgage rates in Canada. The first, and most common, are ones with static monthly payments (i.e. payments that may only change if trigger rates hit). The second, less common, variable mortgage rates are those with floating payments (i.e. payments change automatically with changes to prime rates).
Most Canadians have the former type of variable mortgage that only changes once a trigger rate is reached because generally speaking these static monthly payments protect the borrower’s cash flow from nominal changes in the prime rate. But because over the course of the year the changes to prime rates from the Bank of Canada have been significant, it’s important for Canadians with static payment variable mortgage rates to know that they could see increases made by their borrowers to their scheduled payments.
How is a trigger rate calculated?
For a more accurate understanding of your trigger rate, it’s best to speak with your Financial Advisor. They’ll take the time to listen to you and understand your unique needs and goals. However, by following these steps, you can get an understanding of what to expect:
- Determine the amount you are expected to be charged for each mortgage payment.
- Confirm the number of payments you are required to make in a year (for example, whether your payments are weekly, biweekly, monthly, etc.).
- Check to see how much of the mortgage balance you still have to pay off.
Once you have all these details, you can calculate the approximate trigger rate with the following formula:
(Payment Amount X # of Payments per year / Balance owing) X 100 = Trigger Rate %
- Take your payment amount and multiply it by the number of payments per year, then divide that amount by the balance owing on your mortgage.
- Then multiply that amount by 100.
- The result should give you a rough estimate of your trigger rate.
Keep in mind that this is not your “final” trigger rate, and results may vary.
How would this calculation look?
To help you get a better understand of how your trigger rate might look, consider the following example.
Bret has a $725,000 variable rate mortgage with Coast Capital, for which he makes twelve monthly payments of $3000 each per year.
Balance Owing: $725,000
- Payment Frequency: Monthly (12 payments/year)
- Payment Amount: $3000
Using the equation outlined above, his trigger rate should be 4.97%, as you can see here:
- ($3000 x 12 payments a year/$725,000) x 100 = 4.97%
This information can help Bret start to form a backup plan in case his interest rate climbs too high.
What are my options once a trigger rate is reached?
Speaking with your Financial Advisor can help you outline solid plans in case you reach your trigger rate. The best proactive options to consider before a rate increase include:
- Convert to a Fixed Term
Not all mortgages have variable rates. Others are called fixed rate mortgages, because the amount you pay in interest is the same regardless of whether the prime rate increases or decreases. Though you miss the opportunity to pay a lower amount when the prime rate decreases, you benefit from predictability and the confidence that comes with no longer worrying about triggering any special rates.
- Increase Monthly Payments
By increasing the amount you pay towards your mortgage, you add “cushion room” to your trigger rate. Though you’re still exposed to the ups and downs of the prime rate, you benefit from putting down more towards your principal each month.
Your mortgage is one of the most important parts of your long-term financial plan. You should reflect on your goals before making any changes to your mortgage.
What happens if I don’t take any action once a trigger rate is reached?
Financial Institutions can amend your payment if it is no longer covering the interest and will notify you of this change.
As Prime fluctuates with increases and decreases by the Bank of Canada, as a Variable Mortgage Member, a recommended approach to avoid a Trigger Rate is to connect with your credit advisor when there are predictions of increases.
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This article is provided for general information purposes only. It is not to be relied upon as financial, tax, or investment advice or guarantees about the future, nor should it be considered a recommendation to buy or sell. Information contained in this article, including information relating to interest rates, market conditions, tax rules, fees, and other investment factors are subject to change without notice and Cost Capital Savings Federal Credit Union is not responsible to update this information. All third party sources are believed to be accurate and reliable as of the date of publication and Coast Capital Savings Federal Credit Union does not guarantee accuracy or reliability of such sources. Readers should consult their own professional advisor for specific financial, investment, and tax advice, tailored to their needs, to ensure that individual circumstances are considered properly and action is taken based on the latest available information.