If you have a variable-rate mortgage, the recent rate hikes by the Bank of Canada will have a direct and immediate effect on your mortgage – and you could be at risk of reaching your trigger rate. Not all variable-rate mortgage holders have to worry about trigger rates.
Each mortgage payment is made up of two parts: principal and interest. The principal is the portion of your payment that goes toward your balance owing, while interest is the bank’s fee for letting you use their money.
To help keep things predictable, many lenders offer variable-rate mortgages with fixed payments. Instead of changing the size of your payment every time the prime rate changes, your lender will continue to collect the same amount and allocate a larger or smaller portion of your payment to interest. If you have a variable-rate mortgage with adjustable payments, you have nothing to worry about. But if your variable-rate mortgage has fixed payments, rising interest rates can cause trouble. As your mortgage rate rises, a larger portion of your payment is put toward interest and a smaller portion of your payment goes toward principal.
Your trigger rate is the point at which your regular payment is no longer enough to pay all of the interest. Your entire mortgage payment is going to interest and none of it is going to your principal.
When you exceed your trigger rate the balance on your mortgage may begin to increase and not decrease as would be your original plan. Because your regular payment is no longer enough to cover the cost of borrowing, the entire payment is applied to interest. This is called “negative amortization.”
If your payment changes when the interest rate changes, as is the case with many mortgages, you don't need to worry. If your payment does not change then you need to be aware that your lender could be adding money to the balance of your mortgage and at some point, you may get a call to reduce the balance and or increase the size of your payments.
Variable rate mortgages have been a great way to save interest over the long term. Right now with the unanticipated increase to prime, you need to know if the rate increase has longer term negative effects for you.
