Mortgage Basics #Home Buying

What is a Trigger Rate & How Does it Impact Variable Mortgages?

One of the key focuses in 2022 is around the Bank of Canada (BoC) and its interest rate announcements. For those that may have missed it, since March 2022, the BoC has been increasing its key policy rate, and on September 7th, it did so once again by 75bps. This brought the policy rate to 3.25% and in turn, brought most bank’s’ prime lending rate – which all prime variable mortgages are priced against in the country – to 5.45%. This left many homeowners confused and wondering how their variable mortgages will be affected by these changes as they reach their trigger rates and points. We’re here to clear up any anxiety based on misconceptions. In this blog post, we’ll go over what a trigger rate is, how to calculate your trigger rate, and the various scenarios you may find if you’re in a VRM. Read on and learn more!

Key Takeaways

  • VRM vs ARM: Why not all variable mortgages are affected by trigger rates.
  • The trigger rate occurs when no principal is being paid down.
  • The trigger point occurs when the balance owing on the mortgage is less than the original mortgage amount.
  • Additionally we’ll show you how to circumvent or remedy these types of scenarios if you’re in a VRM.

What is a Trigger Rate on a Mortgage?

The trigger rate is a result of an increasing rate environment where a higher interest rate is being charged to the variable rate mortgage without an increase to the mortgage payment. At this point, none or very little principal is being paid, only interest – in some cases not enough interest is being paid. Essentially, for a variable mortgage to be triggered, only the interest is being paid, to get to that point only the interest has been paid down for a while as rates were increasing. Not all mortgage holders need to worry as adjustable rate and fixed rate mortgage holders are not impacted.

How to Calculate your Trigger Rate?

Every mortgage holder with a variable rate mortgage will have a different trigger rate since it’s based on your mortgage amount, monthly payment and interest rate.  The quickest way to determine your trigger rate is to review your mortgage documents, this would be the initial contract or commitment that you signed with your lender. The trigger rate outlined in your documents implies that you have not made any prepayments during your term as prepayments made to your mortgage will increase your trigger rate.

The formula to calculate your trigger rate will need you to find out your payment amount, number of payments per year (payment frequency) and the balance owing currently.

Payment amount x number of payments per year / balance owing x 100 = Trigger rate in %

So if your payment is $1800 biweekly and you owe $580K then your trigger rate will be 8% calculated as 

$1800 per payment x 26 biweekly payments per year / $580,000 balance x 100 = 8%

What is a Trigger Point?

There is no action required by the borrower when their mortgage hits the trigger rate; however, there is some action required when it hits the trigger point.  When you’ve eclipsed the trigger rate then the balance owing is higher than the principal on the originally loaned mortgage amount, that’s when you’ve hit the trigger point. This would justify a call from your banking advisor or mortgage professional to remedy the situation. The exact dollar amount or loan-to-value ratio that causes the trigger point on your mortgage will vary between lenders.

Don’t let the Trigger Rate trigger your anxiety.

Once you have reached your trigger point, your amortization will start increasing. 

For example, say you’ve put down 20% when you purchased the property: most lenders will allow you to increase the mortgage balance back up to 80% of the property’s value on an uninsured mortgage, where you did not take out mortgage default insurance. 

With insured mortgages, where you put less than 20% down and purchased mortgage insurance from Canada Mortgage & Housing Corporation (CMHC), Sagen (formerly known as Genworth), or Canada Guaranty (CG) to protect the lender in case of default, you would not hit your trigger point until your mortgage balance reaches 105% of the property’s value.

At this point, you will be required to put your mortgage back on track.  

This can come in multiple ways, such as:

  • Principal prepayment to cover the ballooned principal balance – this is not a feasible option for all borrowers unless they have some large savings set aside, or
  • Increase your payment to compensate for the additional payment to the principal (we’re likely talking about only a few hundred dollars at this point), or 
  • Refinance your mortgage to increase your amortization.

VRM vs ARM: Why Trigger Rates only affect VRMs

There are two types of variable rate mortgages – static payment and variable payment.  Static payment variable rate mortgages are more specifically called variable rate mortgages (VRM), and variable payment variable rate mortgages, where the payment adjusts with changes in the prime rate, are more accurately called adjustable rate mortgages (ARM).  Commonly, they are both known as variable rate mortgages; but any expert will tell you that they are quite different.

Table is Set, First Course Principal, Second Course Equity…

For example, if you have two identical mortgages and they are going through a cycle of increasing prime rates more of the payment amount will shift to interest.  

The variable mortgage trigger rate will compensate by increasing the remaining amortization as the payment is fixed. Whereas, the adjustable rate mortgage will increase payment to keep the remaining amortization running in chronological order.  

Say that your payment is $2000 where the interest portion is $1500 and the principal is $500. With this relationship on the time value of money, the principal will reduce to compensate for the increase in the interest portion of the payment on the variable rate mortgage, until the whole $2000 payment is going only to interest.

Conversely, with an adjustable-rate mortgage, the whole payment will increase and keep both the interest and principal portions on an increasing trajectory while rates are rising.

Amortization is the Only Type of [Mortgage] Life That You Want to End Sooner

Typically amortization, that is the life of the mortgage, decreases over time; therefore, when you start with a 25-year mortgage amortized over a 5-year term you will end with 20 years remaining amortization.  

This happens automatically with adjustable rate mortgages, such as nesto’s variable rate mortgage, as they compensate by increasing your regularly scheduled (monthly/biweekly/weekly/accelerated) payment to compensate for the increase to your interest portion.

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Timeless Mortgage Advice During This Inflationary Period

Depending on your risk tolerance and cash flow, you may also renew a fixed rate mortgage to simplify things for yourself at this stage by having a static payment and rate for the rest of your term.  

But to renew at this stage while avoiding penalty would only be an option at your current lender; otherwise, you will have to stress test and potentially re-assess your property value if you need to move to another lender for a better-fixed rate.

We recommend, if you’re getting close to your trigger rate or point, that you speak to your lender proactively well before they reach out to you. Planning ahead by making small changes can have a big impact overall.  

Small changes to help you get ahead of the curve:

  • Principal prepayment, if your lender allows you to make multiple prepayments you can choose to do smaller lump sum payments if you have disposable savings
  • Increase your payment, most lenders like nesto, allow you to increase your payment once a year, this increase should be going right to the principal
  • If you have a collateral charge mortgage that allows you to hold multiple mortgage components, then for a smaller penalty you can convert part of your mortgage to a fixed rate option thus reducing the risk on the whole balance. This option would not require you to re-confirm income or property value as you’re not looking to re-qualify. But we would caution you that if your mortgage components come up for maturity at different times then you could be on the hook for a prepayment penalty if you decide to move your mortgage (all components have to be moved) to another lender at renewal.

Frequently Asked Questions (FAQ)

Do trigger rates impact fixed rate mortgages?

Fixed rate mortgages have a fixed payment throughout their mortgage term. Their total payment each month,  made up of interest and principal portions, stays consistent throughout the term. They do not have trigger rates as they consistently paydown the interest and principal over the course of their term.  Only variable rate mortgages are affected by trigger rates as their share of interest keeps decreasing their share of principal payments as rates increase.

Why is the trigger rate important in 2022?

When rates were low back at the start of the pandemic the Bank of Canada (BoC) had dropped the key overnight lending rate in tandem with the US Federal Reserve (the Fed)  significantly due to slow down in market activity.  This provided lower carrying costs for borrowers to book their mortgages on variable rates and qualify for even more. Many clients decide to overextended themselves with regard to their risk when rates rise. As rates have risen as quickly this year as they fell in 2020, the amount of interest that is being paid down on variable mortgages that have a static payment is fast becoming negligible.

What is the difference between ARM and VRM?

ARM mortgages are variable rate mortgages where their payment changes with changes to their mortgage lender’s prime rate. VRM mortgages are expected to have static payment throughout their term so increases to the prime rate will increase the portion of the payment that is going to interest. Once the trigger rate is reached in a VRM, there is no principal being paid down on that mortgage.

Final Thoughts 

To wrap it all up, a trigger point on a mortgage essentially occurs when the balance owing on the mortgage is higher than the original mortgage amount. At this point either you have to increase your payment or pay down the over-extended balance with a prepayment.  Although nesto doesn’t offer static payment variable mortgages, our advisors are here to help review your loan agreement and see what options are the most suitable for you. 

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