A variable-rate mortgage can save money when rates fall and cost more when they rise. How it costs more depends on a detail many borrowers miss when they sign: whether your payment changes with the rate, or stays the same while the split between interest and principal moves. That second kind is where the trigger rate comes in.
How the rate is set
A variable rate is quoted relative to the lender’s prime rate: for example prime minus 0.75%, or prime plus 0.50%. The discount or premium is fixed for your term. Prime itself is set by each lender, and in practice it moves when the Bank of Canada changes its policy interest rate. The Bank announces its rate decisions on eight scheduled dates a year.
So if prime is 4.95% and your mortgage is prime minus 0.75%, you pay 4.20%. If the Bank of Canada raises its rate by 0.25% and your lender raises prime to 5.20%, your rate becomes 4.45%.
Two kinds of variable mortgage
- Adjustable payments (often called an ARM): the payment goes up or down every time prime changes, so you stay on track to pay off the mortgage over your original amortization. Your budget feels each change right away.
- Fixed payments (often called a VRM): the payment stays the same. When rates rise, more of each payment goes to interest and less to principal. When rates fall, more goes to principal. Your budget is protected, but your payoff date moves.
Ask your lender which kind you’re signing. The names vary between lenders, and the difference only becomes obvious when rates move.
Trigger rate and trigger point
These two terms apply to fixed-payment variable mortgages, and they are not the same thing.
- Trigger rate: the interest rate at which your regular payment covers only the interest, with nothing left for principal. Above it, the payment doesn’t even cover the interest. Lenders generally add the unpaid interest to your balance, so the amount you owe grows. This is called negative amortization.
- Trigger point: the point at which your balance has grown beyond the ratio your lender accepts, for example relative to the value of the home. Once you reach it, you must act: raise your payments, make a lump-sum prepayment, or pay off the balance. The exact trigger point is in your mortgage contract.
Federally regulated lenders must state the trigger rate in your mortgage agreement or disclosure document for a variable mortgage with fixed payments, along with the fact that the rate may rise during the term.
Worked example
You take a $500,000 variable mortgage at 4.20% with a 25-year amortization and fixed monthly payments. The payment is $2,684.59. The figures below are approximations: they assume the rate change happens at the start and use simple monthly interest, while lenders’ exact calculations depend on how they compound variable-rate interest.
| Rate | Interest that month | Left for principal |
|---|---|---|
| 4.20% | $1,750.00 | $934.59 |
| 4.70% | $1,958.33 | $726.26 |
| 5.20% | $2,166.67 | $517.92 |
| 6.20% | $2,583.33 | $101.26 |
| 6.70% | $2,791.67 | −$107.08 (added to the balance) |
The trigger rate is roughly the payment times 12, divided by the balance:
$2,684.59 × 12 ÷ $500,000 ≈ 6.44%
So in this example the rate would have to rise by about 2.25 percentage points before you hit the trigger rate. As you pay down principal, the balance falls and the trigger rate rises a little, which gives slightly more room later in the term.
Notice what happens well before the trigger rate. At 5.20%, the payment is the same but principal repayment has dropped by almost half. The mortgage is now on track to take much longer than 25 years to pay off, and that is easy to miss because nothing changes in your bank account.
Compare the adjustable-payment version. If the rate rose to 5.20% right away, the payment needed to stay on a 25-year schedule would be about $2,965, roughly $281 more a month. You feel the increase immediately, but your payoff date doesn’t move.
What to do if you’re near your trigger rate
- Find your trigger rate in your mortgage documents or annual statement, or ask your lender.
- Raise your payment voluntarily. Most lenders let you increase it within your prepayment privileges, which keeps principal falling.
- Make a lump-sum prepayment if you have savings earning less than your mortgage rate.
- Consider locking in. Many variable mortgages can be converted to a fixed term with the same lender. Check your contract for conditions and costs, and compare the fixed rate offered.
- Talk to your lender early. The Financial Consumer Agency of Canada expects federally regulated lenders to offer relief to borrowers at risk of financial hardship, and lists fixed-payment variable mortgages facing negative amortization as one of the situations it covers.
At renewal
If your balance or remaining amortization has drifted because of higher rates, expect your lender to reset the payment at renewal so the mortgage is back on a schedule to be paid off. That can mean a large jump in the payment. Model it with the renewal calculator well before your term ends, and read the mortgage renewal guide.
Is a variable mortgage right for you?
The penalty for breaking a variable mortgage is often three months’ interest (check your contract), usually much less than the interest rate differential that can apply to a fixed one, which suits people who may move or refinance. It suits you less if a payment increase would strain your budget. See fixed vs variable mortgages for the full comparison and the penalty calculator to compare break costs.
Sources: Bank of Canada, policy interest rate; FCAC, interest on mortgages; FCAC, getting a mortgage: know your rights; FCAC, variable-rate mortgages with fixed payments; FCAC, backgrounder on the Guideline on Existing Consumer Mortgage Loans in Exceptional Circumstances; FCAC, prepayment penalties.