The “trigger rate” in the context of a mortgage, particularly a variable rate mortgage with fixed payments, is a specific interest rate at which the fixed monthly payments are no longer sufficient to cover both the interest and principal repayment. When the interest rate rises to the trigger rate, the structure of the payments may need to be adjusted.
Let me give you a more detailed explanation:
Consequences of Hitting the Trigger Rate
Variable Rate Mortgages
In a variable-rate mortgage, the interest rate fluctuates based on a benchmark rate, like the prime rate. If you have a variable-rate mortgage with fixed payments, your monthly payment amount stays the same even as interest rates change.
How the Trigger Rate Works
Initially, your fixed payments cover both the interest and a portion of the principal. However, if interest rates rise significantly, a larger portion of your payment goes towards the interest. The trigger rate is the point at which the interest rate has increased so much that your regular fixed payment is only covering the interest, with nothing or very little going towards reducing the principal.
Consequences of Hitting the Trigger Rate
When the trigger rate is reached, the lender will typically review the mortgage. This could lead to several outcomes:
Increase in Payment Amount:
To ensure the mortgage is paid off within the original term, the lender might increase your monthly payment.
Change in Mortgage Structure:
The lender might suggest converting to a different type of mortgage, like a fixed-rate mortgage, to provide more stability in payments and interest costs.
Extension of Amortization Period:
In some cases, the lender might extend the length of time over which the mortgage is repaid (the amortization period), though this would lead to more interest paid over the life of the mortgage.
Importance for Borrowers
Understanding the trigger rate is crucial for borrowers with a variable-rate mortgage. It helps in assessing the risk of payment increases and in planning finances accordingly. Borrowers should be aware of their mortgage’s trigger rate and consider their ability to handle potential increases in payments.
Undisclosed Risks
Many Canadians who purchased their mortgage through a bank’s unlicensed salespeople instead of a provincially licensed mortgage agent did not have this risk explained to them when they were sold their mortgage, as there is no requirement on the part of a salesperson to do so. Mortgage agents, unlike bank salespeople who work on quota, are required to disclose the risks of mortgage products to clients. By understanding what a trigger rate is, clients can make informed decisions about their mortgage options.
