The quarter of a percentage point increase in the central bank’s trendsetting rate has some borrowers worried about a little-known feature of many variable-rate mortgages known as the “trigger rate.” It’s the interest rate level at which lenders can adjust up a mortgage holder’s payment amount even if it would normally be the same every time.
If you have a variable mortgage rate with stable payments, the likelihood that you’ll hit your trigger rate depends on your mortgage balance and interest rate, Jamie David, director of mortgages and head of marketing at online rates comparison site Ratehub.ca, said via e-mail.
The question you’re likely wondering about now is: How close is the trigger point?
When the central bank’s key rate changes, banks usually adjust their own prime rates, the benchmarks to which variable rates are pegged. Many variable-rate mortgages, though, come with payments that are normally held constant. Rather than increasing the mortgage payment when rates rise, lenders apply a greater portion toward the interest rather than the principal. Borrowers, in turn, see their amortization period extended, meaning it will take longer to pay off their mortgage balance.
But those mortgage payments can increase if interest rates rise so much that a borrower’s regular payment amount would no longer be enough to make a dent in the principal. The trigger rate is generally a rate at which the borrower’s payment would not be enough to cover the interest.
For those unsure where that line is, Toronto mortgage broker Frances Hinojosa has a simple formula she uses to help clients. The back-of-the-envelope calculation is approximate, and borrowers should confirm directly with their lender where exactly their trigger rate lies. Mortgage holders can also usually find their trigger rate in their mortgage contract.
Still, the simple math can be helpful for variable-rate mortgage holders who don’t have their mortgage papers at hand and anyone weighing whether to take out a variable-rate mortgage right now, said Ms. Hinojosa, who is co-founder and CEO of Tribe Financial Group.
If you have a variable mortgage rate with fixed payments, you can estimate your own trigger rate with the calculator below.
Nearly three in every 10 homeowners with a mortgage had a variable interest rate at the end of 2021, according to data compiled by the Bank of Canada. Of those, four out of five had fixed payments, the numbers show.
If you have a variable rate with fixed payments, the first step to estimate where your trigger rate lies is to calculate how much you currently pay toward your mortgage in a year, according to Ms. Hinojosa. If you pay monthly, multiply your regular mortgage payment by 12. If you pay twice a month, multiply by 24. If you pay every two weeks, multiply by 26 (paying bi-weekly means you’re making two extra payments every year compared with paying semi-monthly). And if you pay every week, multiply by the 52 weeks of the year.
Once you have your annualized payment, divide it by your current mortgage balance, then multiply by 100. The resulting number is a good approximation of your trigger rate, according to Ms. Hinojosa.
For example, take a borrower with an outstanding mortgage balance of $485,253 and a bi-weekly payment of $1,051.06. With an annualized payment of $27,327.56, this mortgage holder’s trigger rate would be around 5.63 per cent.
The exact way lenders calculate the trigger rate varies, Ms. Hinojosa noted. What happens when you hit that rate also depends on your mortgage provider and individual situation, she added.
If you reach the trigger rate, your lender will notify you and usually lay out some options, Ms. Hinojosa said. These may include increasing your payments, making a lump-sum contribution to your mortgage or locking into a fixed rate, she said.
It is “quite possible” that borrowers will see payment increases given how aggressively the central bank has been pushing up interest rates, mortgage planner Robert McLister said. The risk is especially high for variable-rate holders whose interest rate was set at a relatively low discount compared to their lender’s prime rate, he added.
The January announcement is the bank’s eighth consecutive rate increase, and brings the policy rate to 4.5 per cent. That is the highest level since early 2008. Markets were expecting a smaller 25-basis-point increase.
Development by Andrew Saikali and Carys Mills.
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