We have already seen the Bank of Canada raise interest rates to levels that we have not seen in an extremely long time. On October 26, 2022, the Bank of Canada will make its next interest rate announcement and it is widely believed that we will see a further increase in interest rates of between .25% to .75%. This will have an impact on consumers with variable rate mortgages, particularly those that have fixed-payment variable rate mortgages.
A fixed-payment variable rate mortgage is a mortgage payment that stays the same, regardless of fluctuation in the underlying interest rate. This option provided many consumers with the benefits that a fixed-rate mortgage provides, while also being able to take advantage of the historically low prime rates we have seen. While in most markets this set up would be perfectly fine, we are entering a variable interest rate in which some people are barely paying down any principle on their mortgage.
This is something that is not often talked about, and most consumers still believe that their mortgage will be paid off in 25 years. Unfortunately, with interest rates at their current levels, those who are in fixed-payment variable rate mortgages are approaching their “Trigger Rate”. Your trigger rate is essentially when you are no longer paying any principal on your mortgage, resulting in your lender increasing your fixed payment. This could be quite difficult for some people to manage but I can assure you, it is in your best interests to focus on paying down the principal on your mortgage. This is something that is not covered very much in the media and a mortgage you thought would be paid off in 25 years is actually looking more like 45 years at the current rates.
The video below breaks down the impact that the new interest rates have on a $500,000 mortgage that started prior to the Bank of Canada increasing their interest rates and shows you what that same mortgage looks like today.
You can calculate your own trigger rate with the following formula: (Payment amount X number of payments per year / balance owing) X 100) to get your trigger rate in percentage.
If you have reached your mortgage trigger rate, don’t panic., you have a few options:
- Adjust Your Payment: Firstly, you may choose to adjust your payment amount to ensure that you still have some going towards your principal balance.
- Review Your Amortization Schedule: Consider switching your amortization schedule from 20-year to 25-year which would be ideal if you already have equity in your home. However, if you’re already at your maximum amortization for your lender (i.e. 30-year mortgage), you would need to increase your payment.
- Switch to a Fixed-Rate Mortgage: Many borrowers are now choosing to opt for a fixed-rate mortgage to avoid the issue of increased interest and trigger rates. Keep in mind, depending on your mortgage product, you may face penalties if you switch your mortgage mid-term. Be sure to discuss any mortgage changes with me before going ahead.
- Consider Shifting Some of Your Investment Portfolio Into Your Mortgage: At the current interest rates, and based on the fact you pay your mortgage with after tax dollars, you would be getting quite a decent return by paying down your mortgage and saving on that interest payment. You can look to see how well (or not) your portfolio is doing. If you are getting less than a 6% return, I would consider shifting some funds.
- Pay Off Your Mortgage: The final option that is always there is for you to pay off your mortgage entirely. Though don’t fret if this is not possible!
In the overall picture, it is likely we will see the Bank of Canada drop their interest rates once inflation has leveled out. Of course, we do not know when that will be so it is very important that you review your current mortgage and financial situation to ensure you are protected in the event rates stay at this level for an extended amount of time.
While we recommend you have a conversation with a mortgage professional or a financial planner, you can always contact us to have a free consultation and we would be happy to point you in the best direction possible.