What hitting your “trigger rate” will do to your finances

Homeownership provides a source of stability and has been a relatively safe investment opportunity for many years. But rising interest rates have left those with variable-rate mortgages on shaky ground and quickly approaching their "trigger rate."

Driving the news: Banks are contacting clients to warn them that more interest rate hikes ahead of the Bank of Canada's (BoC) next announcement on October 26, could mean they have to pay more towards their monthly mortgage, per the Globe and Mail

  • The "trigger rate" is the interest rate at which a lender can increase your monthly payment if the current amount isn't covering the interest on the loan (let alone paying off any of the principal).
  • If the BoC raises the benchmark interest rate above 4%, 350,000 mortgages could hit their trigger rate. 

Why it's happening: Variable-rate mortgages, which are typically lower than fixed-rate mortgages, were appealing for many years as interest rates trended down. Everyone was like, "free money, let's buy a mansion!" 

  • The trade-off for a lower rate is that variable-rate mortgages can increase along with interest rates (whereas fixed-rates stay the same until renewal time).

Why it matters: People are already stretched thin financially—for those approaching their trigger rates, increased payments could become a substantial financial burden they may not have been prepared for. 

  • Before the interest rate hikes, a $2000 mortgage payment on a 1.45% 25-year mortgage would have seen over 75% go towards paying down the principal—only $440 would go towards interest, Ron Butler told the Globe and Mail.

  • Today that payment would increase $21 and all of it would go towards interest.

  • And this is just the start. People who secured mortgages in 2020 or 2021, won't feel the real pain until they renew their mortgage in three or four years. 

When you hit your trigger rate, your broker will give contact you to adjust your mortgage by increasing your monthly payments, extending your amortization period or both. You also have the option to:

  • Pay down your principal. It might be wise to make a lump sum payment towards the loan, reducing interest payments. And if for some reason you have a lot of cash lying around, you could also just pay off your mortgage (easy, right?).
  • Change mortgages. You could switch to a fixed rate—but you'd be locking yourself into high rates, though some people are nevertheless choosing this route.

Bottom line: Analysts forecast the BoC will announce a 50 to 75 basis-point hike next week, so if you've got a variable rate mortgage, now is the time to start planning how you'll deal with higher payments.