The trigger rate is the point where your regular mortgage payment no longer covers the interest amount that accrues each period. Once you hit your trigger rate, any unpaid interest is added back to your principal amount, causing it to increase rather than decrease. Mortgage trigger rates exist to help mortgage holders continue to increase the amount of equity in their mortgages.
In this article, we'll look at the mechanics of mortgage trigger rates, why they're important for homeowners to understand, and how they can impact your financial future.
Key Takeaways
- A mortgage trigger rate happens when the fixed payment in a variable rate mortgage no longer covers the interest.
- When a mortgage holder hits their trigger rate, the equity in their home doesn’t increase because they’re not paying down the principal.
- If you’re approaching your trigger rate, talk to your lender about your options, such as adjusting payment amount or frequency or refinancing your mortgage.
What is a mortgage trigger rate?
A mortgage trigger rate occurs when interest rates rise to a point where your monthly payment is no longer enough to cover the interest you owe. When this happens, any interest not covered by your payment gets added to the total you owe on your mortgage.
Trigger rate for variable mortgages
In a variable mortgage with fixed payments, the monthly payment stays the same no matter what, but the proportion of the payment that goes to interest vs. principal increases as interest rates rise. The trigger rate happens when the interest due exceeds the payment amount.
The majority of Canadians with variable mortgages have fixed payments. In fact, according to data from the Bank of Canada, by the end of 2021, about 30% of homeowners with a mortgage had a variable interest rate. Among these, 80% made fixed payments.
To learn more about how prime rate impacts your mortgage, read: How Does The Prime Rate Affect Your Mortgage Rates?
Trigger rate for fixed mortgages
There’s no trigger rate in a fixed rate mortgage because the interest rate is locked in on these mortgages for the length of the term. Therefore, the proportion of payment going toward interest vs. principal is unchanged and unaffected by prime rate changes. You’ll know exactly how much principal you will have paid down by the end of the term.
According to the 2023 CMHC Mortgage Consumer Survey, fixed rate mortgages were chosen by:
- 60% of first-time homebuyers
- 58% of repeat buyers
- 73% of renewers
- 53% of refinancers
How to calculate your mortgage trigger rate
To calculate your mortgage trigger rate, you first need to know a few key details about your mortgage:
- The current balance
- The interest rate
- Your regular payment amount
Consider a mortgage of $400,000 taken out in 2020 at an initial interest rate of 1.5% per year. Assuming this loan is amortized over 25 years, the monthly payment will be approximately $1,600.
To find the trigger rate, calculate when your monthly payment of $1,600 doesn't cover the interest due anymore.
To do this, use the following formula:
(Payment amount * # of payments per year / Balance owing) * 100 = Trigger rate %
For this particular mortgage, this would look like:
(1,600 * 12 / 400,000) * 100 = 4.8%
If the interest rate rises above 4.8%, the interest owed will be higher than the $1,600 monthly payment.
Let’s demonstrate how this plays out as interest rates rise:
- The original mortgage: At 1.5% annually (or about 0.125% monthly), your monthly interest is about $500 (0.00125 * $400,000 = $500), which is well below your payment of $1,600. This still leaves $1,100 to pay down the principal of the loan.
- Mortgage at trigger rate: At 4.8% annually (or about 0.4% monthly), your interest for the month would be $1,600 (0.004 * $400,000 = $1,600) – just enough to cover the interest on the loan.
- When rates rise above trigger rate: If the rate rises to 6% (or about 0.5% monthly), your interest for the month would be $2,000 (0.005 * $400,000 = $2,000). At this rate, the $400 in unpaid interest would be added to your original loan amount.
What to do when you hit your mortgage trigger point
When you reach your mortgage trigger rate, it's important to take action to prevent your loan balance from growing. Here are some steps you can take:
- Increase your payments: If you can afford it, raising your monthly payments can help keep your loan balance from increasing. This helps you cover the increased interest and starts reducing the principal again.
- Make a lump-sum payment: If you have some savings, you might consider making a large, one-time payment. This reduces your principal balance, which in turn lowers the amount of interest you'll owe in the future.
- Change your payment frequency: Switching from monthly to bi-weekly payments can also help. You’ll make more payments in a year, which speeds up paying down your principal and reduces the total interest you’ll pay over the life of the mortgage.
- Refinance your mortgage: Sometimes, finding a fixed-rate mortgage or a lower interest rate can be a good choice. This might involve some fees and penalties, but it could save you money in the long run, especially if it helps you avoid hitting the trigger rate.
- Talk to your lender: They can offer advice specific to your situation. They might have options to help you manage your payments better or suggest other suitable financial solutions.
FAQ
What is the trigger rate on a variable mortgage?
The trigger rate on a variable mortgage is the interest rate at which your fixed monthly payment no longer covers the amount of interest due, causing the balance of your loan to increase rather than decrease.
What happens when you hit a trigger rate in a mortgage?
When you hit your trigger rate, it’s wise to speak to your lender about your options. Some possible next steps could include increasing your mortgage payment or switching to a fixed-rate mortgage.
Do fixed mortgages have a trigger rate?
Fixed mortgages don’t have a trigger rate because the interest rate and monthly payment remain constant for the full term of the loan, ensuring each payment adequately covers the interest and reduces the principal.
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