What they are, when they take effect, and who they affect. And how to get around them.
There has been a lot of talk in the media lately about “Trigger Rates”, but not a lot of information about what they really are. First, we must understand what a Variable Rate Mortgage actually is.
VRM vs ARM
When most speak of “Variable Rate” mortgages they are actually referring to two different products: the “Variable Rate Mortgage” (VRM) and the “Adjustable Rate Mortgage” (ARM). While they sound similar there are some important differences.
Banks and Credit Unions typically offer a “Variable Rate Mortgage” which is characterized by an Interest Rate which is tied to Prime Rate (which in turn, is tied to the Bank of Canada Overnight Lending Rate) and so changes over time. The interest rate quoted on the mortgage is normally compounded monthly (interest is recalculated every month), which results in a higher interest cost than “simple” interest (= compounded once per year).
In the event of interest rate fluctuations, Payments normally don’t change, however, the proportion of the Payment going to Principal and Interest does, resulting in a change to Amortization (as interest rates increase, the proportion of the payment going to Interest increases, while the proportion going to Principal decreases, resulting in a longer Amortization … and vice-versa).
“Adjustable Rate Mortgages” are offered by non-Chartered Bank lenders (like First National and MCAP), and the interest rate is typically compounded semi-annually (interest calculated every half-year): this results in an interest cost slightly higher than a comparable “simple” interest rate, but considerably less than when compounded monthly. Note that Fixed Rate mortgages are also normally compounded semi-annually.
ARM mortgage Payments change automatically with Prime Rate, such that the Amortization doesn’t change: as Prime Rate goes up, so too, do payments on ARM mortgages; as Prime decreases, ARM mortgage payments decrease. If your payments have been increasing regularly with Prime Rate this year, you actually have an ARM mortgage, not a VRM.
The Trigger Rate on a VRM is the point at which the Interest proportion of the mortgage Payment exceeds 100%, and so the Amortization increases to infinity! It is called the “Trigger Rate”, because when your mortgage reaches this state, the Bank automatically increases your payment to achieve a more reasonable Amortization. The calculation is different for every mortgage, so there is no one Trigger Rate for all VRM mortgages. Because payments change in lockstep with with interest rate payments on Adjustable Rate Mortgages, there is no such thing as a Trigger Rate for an ARM mortgage.
VRM: What To Do About a Trigger Rate
If you do have a Variable Rate Mortgage, most lenders have some kind of “Rule of Thumb” for calculating the Trigger Rate, however is safe to say that most VRM mortgage holders are close to it right now. The best and easiest thing to do about it, is to take control of your mortgage by increasing the Trigger Rate. To do this is quite simple, as VRM (& ARM) mortgages nearly universally have a provision to increase the regular payments: depending on your current payment, a relatively small voluntary increase in the Payment will increase the Trigger Rate substantially and avoid a higher payment calculated by the Bank’s computers!