Mortgage trigger rate: definition and issues

Introduction

Are you considering taking out a mortgage soon or is your mortgage loan already being amortized? Discover the trigger rate, a concept that allows you to better manage your finances and anticipate an extension of the amortization period or a possible increase in your credit monthly payments. When does the trigger rate of your mortgage loan occur? How to calculate it? What types of mortgages are concerned? What are the risks if this threshold is reached? Here is essential information to know about the trigger rate of your mortgage loan.

How to calculate and know the trigger rate?

The trigger rate is a context that can specifically concern variable rate mortgage contracts with fixed payments or VRM. If you have signed this type of mortgage, it is particularly recommended that you have an idea of what the trigger rate is, especially in periods of rising interest rates.

• • What is the trigger rate of your mortgage loan?

For a variable rate mortgage VRM, each monthly payment is split into two distinct components: one serves to repay the principal borrowed and the other to amortize the interest. Since the amount paid each month is invariable, it is the values of these portions intended for the principal and interest of the loan that fluctuate according to the variation of the interest rate. Suppose the fixed monthly payment of your mortgage loan is $1,800. Part of this amount is intended for interest payment, $1,100 for example, and the other for principal repayment: $700. In a bullish context, interest rates applied by lending institutions can increase continuously for a fairly long period. From January 2022 to November 2023, average interest rates for variable rate mortgages jumped in Canada, going from about 1.5% to more than 7%. When interest rates increase, the greater part of your fixed payment is therefore allocated to interest payment and a smaller portion to principal repayment: $1,600 of your $1,800 payment can then be allocated to interest and only $200 to principal. If interest rates continue to increase, the portion intended for interest will increase further. At some point, the entirety of your monthly payment of $1,800 will be used to pay only interest, without principal repayment. You will then have reached the trigger rate of your mortgage loan.

• • How to calculate the trigger rate?

You can calculate the trigger rate of your mortgage yourself. With this in mind, you must know and use three pieces of information about your mortgage loan:

• • the value of your monthly payments;

• • the frequency of your payments or the number of payments made per year;

• • the current amount remaining to be amortized of your mortgage loan.

The trigger rate is calculated as follows: Trigger Rate (%) = (Monthly payment value x Number of payments per year) / (Current loan balance x 100) If your payment is for example $1,800 per month and you make 12 payments per year and the current amount to be amortized for your loan is $300,000, the calculation is: ($1,800 x 12) / $300,000 x 100 = 7.2%. Your trigger rate is 7.2%. The trigger rate is different for each borrower, as it depends on your loan amount, your payments, and your interest rate.

• • How to know the trigger rate?

One of the simplest methods to know the trigger rate of your mortgage loan is also to consult your loan agreement. This information is generally indicated in the documents you signed with your lender. The rate specified in these documents is nevertheless based on the assumption that no early repayment has been made since the beginning of your payments. If you have made advance payments, your trigger rate is logically higher.

What are the factors that influence the trigger rate?

Many interdependent elements act on the trigger rate of your mortgage loan. The best-known factor is the increase in interest rates. When the Bank of Canada raises its key rate, lenders also increase their prime rates. The impact of such a context is directly felt on variable rate mortgages. The cost of your mortgage then increases proportionally to the evolution of interest rates. As your monthly repayments remain fixed, a larger portion of your payment is then devoted to honoring interest. The remaining duration of your mortgage also influences the trigger rate. A loan with a longer amortization period means that your monthly payments are smaller and their value is therefore more likely to be insufficient to cover interest in case of rate increases. The amount of borrowed funds also plays a significant role. The higher the value of your financing, the more exposed you are to the risk of reaching the trigger rate.

Comparison: fixed rate (ARM) vs variable rate (VRM) and their relationship with trigger rates

Variable rate mortgage loans are divided into two main categories: adjustable rate loans ARM and variable rate loans VRM. While both types of mortgages are linked to interest rate fluctuations, their operation differs considerably. A good understanding of the characteristics of your mortgage loan as well as monitoring market interest rate variations is necessary to anticipate changes in your monthly payments.

• • What to know about adjustable rate mortgage loans ARM?

With an ARM loan, the interest rate fluctuates according to the lender’s prime rate. Mortgage payments increase or decrease according to interest rate variations. If interest rates rise, your monthly payments also increase, and vice versa. The main advantage of an ARM loan is that your payments adjust to interest rate variations. You then maintain your initial amortization schedule despite an increase in interest rates. Conversely, if rates fall, you immediately benefit from lower payments. This type of loan is not directly affected by the trigger rate, but with payments that can increase significantly in case of rapid rate increases, managing your budget can be severely tested. There is also uncertainty about the future evolution of your payments.

• • What are the particularities of variable rate mortgage loans VRM?

Since the VRM loan has fixed payments throughout the term duration, the distribution between interest payment and capital repayment varies according to interest rates. Initially, VRM loan interest rates are often lower than those of fixed loans, allowing you to achieve significant savings. If interest rates decrease, a larger share of your payments is devoted to principal repayment, which can help you repay your loan faster. When interest rates increase, an increasingly large share of your payments is devoted to interest: you then risk reaching the trigger rate of your mortgage loan. If rates continue to rise, your payments may be sufficient to pay only interest, without repaying the principal. Such a situation can lead to an extension of your amortization period and financial difficulties.

• • Advantages and disadvantages of these financing solutions:

Loan Type	Advantages	Disadvantages
Adjustable Rate (ARM)	Preservation of amortization scheduleReduced payments in case of interest rate decreases	Increased payments in case of rate increases,Uncertainty about future payment amounts
Variable Rate (VRM)	Potential initial savings with often lower ratesFaster principal repayment in case of rate decreases	Risk of reaching the trigger rate and no longer repaying principalPotential increase in amortizationFinancial difficulties in case of rate increases

What happens when the trigger rate is reached?

The impact on a borrower’s financial management can be significant if their mortgage loan crosses the trigger rate. A revision of loan conditions is the most likely consequence of such an event. If your lender finds that the monthly payment is no longer adequate, they may ask you for a payment amount increase to ensure that your mortgage loan is repaid on time. The most plausible changes may for example be:

• • the lending institution may require the borrower to increase their monthly payment, either marginally, to prevent the decrease in borrowed principal repayment, or more significantly, to preserve the initial proportion of interest and principal.

• • the lender may also request early repayment to reduce the principal amount. This option is not accessible to all borrowers, but it allows reducing the mortgage balance to be repaid and increasing the trigger threshold.

When the borrower cannot meet these new requirements, the risk of having to refinance their mortgage loan or even sell their real estate becomes higher. A significant increase in monthly payments can indeed be difficult to absorb, especially in an inflationary context. In such a scenario, the borrower may be forced to sell their property to meet their financial obligations. Many homeowners who opted for a variable rate loan when interest rates were historically low found themselves near their trigger rate after the rapid rate increases by the Bank of Canada since 2022. If the monthly payment no longer covers all the interest, the borrower finds themselves in a negative amortization situation: the mortgage balance increases instead of decreasing. Since the principal is no longer repaid or very little, the loan amortization period then extends considerably. For the particular case of a borrower, their amortization period went from 25 years to more than 47 years.

How to avoid reaching the trigger rate?

To strengthen your financial security against the vagaries of your mortgage interest rates, it is strongly recommended to adopt a proactive approach. Regular monitoring of interest rates should be one of your priorities when your mortgage loan is at a variable rate. In this case, you should get into the habit of anticipating interest rate increases by adjusting your monthly payments to increase the amount devoted to principal repayment. This approach allows you to reduce the remaining balance to pay and protect yourself against possible increases. It is also wise to build an emergency fund that can serve to cover higher mortgage payments in case of interest rate increases. If you are a mortgage candidate and the trigger rate is a question that worries you, you can always negotiate a fixed rate loan to protect yourself against strong rate increases. Whatever your situation and projects, the support of a mortgage broker proves very useful for developing a personalized strategy adapted to your particular context. A professional can analyze your situation and offer you tailor-made solutions to optimize your amortization management and protect you against risks related to interest rate fluctuations.

Conclusion

Having a good understanding of the trigger rate of your mortgage loan is essential to ensure the stability of your finances. This threshold, once reached, means that your payments are no longer sufficient to repay your principal. To avoid it, it is essential to regularly monitor interest rates and simulate different scenarios. Stay vigilant and do not hesitate to approach a mortgage broker to consider various actions, such as increasing your payments. Thanks to this strategy, you are able to better anticipate possible difficulties related to interest rate fluctuations and preserve your purchasing power.