What is a Trigger Rate Mortgage ?

Trigger Rate Mortgage-the term itself has grown in concern and importance, especially for variable rate mortgage holders.

The recent increase in interest rates means many are now hitting their trigger rates, which significantly will affect mortgage payments.

This article explores what a trigger rate mortgage exactly is, how it impacts monthly payments, and the options of the borrowers in general.

By the end, you will have a deep understanding of exactly how the mortgages-the variable rate mortgage in particular-can be influenced by interest rate changes and respective risks and benefits involved.

How does it affect your payment ?

The trigger rate is the point at which the interest portion of your variable mortgage payments exceeds the entire amount of the payment, so that none of the payment is going toward the reduction of the mortgage balance.

When you reach your trigger rate, your regular mortgage payment will no longer cover the entire payment for both the principal and the interest.

In other words, it is the point at which the increase in the interest rate of a lender makes your monthly payment insufficient to pay the interest accruing.

The concept of a trigger rate becomes critical for mortgage borrowers using variable-rate mortgages because at this juncture, your payment must increase, or you will have other financial implications like the extension of your mortgage term or, worse still, negative amortization, where the balance of the loan grows instead of shrinking.

Mortgage Payment: Breakdown

Mortgage payments consist of two major parts: principal and interest.

The former is a portion of your payment, which goes to reduce the amount borrowed under the loan, while interest is what your lender charges you for using their money.

Most mortgages have relatively small changes-if any-in the payment amount over the term of the mortgage, and this is especially true for fixed-rate mortgages.

For variable-rate mortgages, however, payments may increase or decrease based on changes to the interest rate.

A mortgage repayment can be basically calculated upon mortgage balance, mortgage interest rate, and amortization period, which in turn denotes the time to be spent to pay off the loan.

As a borrower, if the interest rates increase or you decide to make extra payments, such as a one-time payment, your monthly payment can increase, so you will pay off your balance sooner.

Variable Rate Mortgage: Flexibility and Risks

A variable rate mortgage provides flexibility in that the interest rate would float with the prime rate of the lending institution, which may be changed at any time at the discretion of the Bank of Canada.

At the outset, most variable rate mortgages are granted a lower interest rate compared to fixed-rate mortgages.

This is particularly enticing for those borrowers wanting to minimize their mortgage payment, since the economy may be in a low-interest-rate phase.

On the negative side, the variable rate mortgage leaves borrowers very exposed in case of an increase in the amount of mortgage payments.

This is because if interest rates increase, the amount of interest owed on a loan could grow, hence driving your payment up or closer to your trigger rate.

For example, if the Bank of Canada raises the prime rate, then your lender’s prime rate also goes up, which in turn increases your mortgage interest rate.

Therefore, your required monthly mortgage payment will increase if you have not reached your trigger point yet.

If a borrower has a variable mortgage rate, they should calculate their trigger rate from time to time for preparation for any possible variation in monthly payments.

Fixed Rate Mortgage: Stability and Predictability

In contrast, a fixed rate mortgage is one in which the interest rate remains constant for the full term of the mortgage.

In other words, your monthly mortgage payment will be identical every month, regardless of whether interest rates drop or increase.

As a rule, the borrowers who favor predictability of payment will choose fixed-rate mortgages because they serve to protect the homeowner from high interest rates.

Fixed-rate mortgages are especially good when interest rates are going to increase.

If you can get a mortgage with a low fixed rate of interest, you won’t have to worry about higher payments if the rate of interest goes up.

On the other hand, fixed-rate mortgages generally have a higher starting interest rate than variable rate mortgages, so your mortgage payment might be higher at the outset.

Variable Rate Mortgages: The Impact of Increasing Interest Rates

One of the single largest challenges facing variable rate mortgage holders is increasing interest rates.

As interest rates rise further, the home owners with a variable interest rate mortgage may face an increase in their monthly mortgage payment, which could financially strain them.

That the Bank of Canada increases interest rates, this action automatically means that the prime lending rate will increase, to which variable interest rate mortgages are directly tied.

So many mortgage contracts have fixed payment structures, meaning the amount paid doesn’t change when interest rates increase.

However, with such a switch to a fixed amount mortgage payment, it only means the increased part of the payment will go to interest rather than reducing the principal.

For example, when you reach your trigger rate, the interest portion of your payment exceeds the amount of your original payment; therefore, your regular mortgage payment is insufficient to cover all of the accruing interest.

Some of the potential consequences may include higher payments or an extended amortization period.

Mortgage Payments Within a Variable Rate Perspective

When you’re on a variable mortgage, it’s very crucial to understand how fluctuations in interest rates could affect your mortgage payments.

The balance of your mortgage will determine the amount of interest you owe, and as rates rise, so could your monthly mortgage payment if you’ve reached your trigger point.

To prevent financial burden, most lenders have the options of readjustment of your fixed monthly payment or accept lump sum payments to reduce the mortgage balance.

Some borrowers prefer converting to a fixed rate mortgage and ensuring one interest rate for the whole amortization period, thus preventing further changes in their payments.

Fixed vs. Variable Rate Mortgage: What’s the Right Choice?

Choices between fixed rate and variable rate mortgages often depend on your financial situation and risk tolerance.

Fixed Rate Mortgages offer the security of the same, regular monthly payments plus a rate that does not change throughout the term of the mortgage.

If predictability is the key and you want to avoid the risk of possibly rising rates, then the fixed rate mortgage may be your best option.

Whereas Variable Rate Mortgages have a lower initial interest rate, there is the risk that higher interest rates may boost the amount paid by a substantial degree.

The variable mortgage holder will benefit from lower rates when the economic times are good, but they must also be prepared for rate increases.

Prime Rate and Its Impact on Mortgage Rates

The variable mortgage rates depend a great deal on the prime rate.

The Bank of Canada influences the prime rate, which is basically the rate at which the banks can lend money to their most creditworthy customers.

This means that when the prime lending rate goes up or comes down, the lenders will raise and lower their variable mortgage rates, respectively.

That makes the interest rate which you will have to pay, higher or lower, which is usually related to changes in your mortgage balance or your monthly mortgage payment.

With adjustable rate mortgages-a category of variable mortgages-the monthly payment will also vary with the adjustment in interest rate and provide less predictability than would be provided by a fixed mortgage.

It is because of this fact that it becomes very important for the borrowers of adjustable rate mortgages to keep a close eye on the interest rate trends.

How to Manage Your Mortgage to Avoid Trigger Rates

The most challenging part for a variable rate mortgage holder is trying to stay away from the trigger rate.

The moment the trigger rate hits, for sure, one faces a higher amount of payment covering the accruing interest.

Most do lump sum payments to reduce the outstanding balance so as not to hit the trigger point.

Other strategies involve locking into a fixed mortgage payment structure or even switching to a fixed mortgage.

By locking into a fixed interest rate, you avoid the uncertainty of any rate increase; your mortgage payment amount becomes fixed.

Amortization Period and Its Role in Your Mortgage Payment

The amortization period refers to the amount of time that your mortgage payments will be spread over.

As a general rule, the longer your amortization period, the less your monthly payments will be; however, you pay more in interest in your lifetime.

A shorter amortization period has larger payments but less accrued interest overall.

As rates rise, some borrowers extend their amortization period when payments start getting unbearable, such as when the rates reach the trigger rate.

In turn, that can extend the repayment of a loan and inflate the total interest to be paid.

Getting Ready for the Increase in Interest Rates

With the Bank of Canada hinting at further rate increases, mortgage holders need to take immediate steps to protect themselves from higher monthly repayments.

Hints would be more than something that variable interest rate borrowers need to be concerned with, since they directly relate to changes in the prime rate.

Mortgage borrowers can protect themselves against rising rates by considering the following strategies:

Pay lump sum amounts to bring down the balance owing your mortgage balance.

One could consider a fixed rate mortgage if concerned about the probability of future increases in the rates.

Regulate the mortgage contract and the interest portion in your payments periodically.

Calculate the trigger rate so that you will understand when you may have to adjust the amount of your payment.

Conclusion: How to Handle the Complexity of the Mortgage Payment

The basis of all informed financial decisions lies in the interaction of interest rates with mortgage types and trigger rates.

While the variable rate mortgages, though flexible, bear risks of escalating payment, especially when the interest rates increase, fixed rate mortgages remain stable, having higher initial interest rates.

Ultimately, mortgage holders must weigh the pros and cons of each option against one another and be prepared for any possible changes in interest rates.

Be it a variable mortgage or a fixed-rate one, it is important that you go through your mortgage documents from time to time and consider how future rate changes will affect the whole payment amount and your overall financial situation.