Variable Rate Mortgages

Prime rate is the benchmark rate that lending institutions use to determine lines of credit, mortgages, and personal loans.

Like the United States’ federal reserve, the Bank of Canada (BoC), is Canada’s central bank and is responsible for directing the economic and financial welfare of Canada.

• The BoC meets eight times each calendar year to analyze the Canadian economy and to decide on whether they should lower the overnight rate, raise the overnight rate, or keep rates neutral.
• At these meetings, the BoC will also announce any policy changes or updates that would otherwise impact the general Canadian economy.
• Historically, the government does not make changes to the overnight rate when they meet.
• Over the past 10 years, we’ve seen the variable rate stay fairly flat, with minimal fluctuation.
• Over the past 30 years, whenever we found ourselves in a rate rising environment, it’s been on average 13 months of rates rising, followed by an average of 4-6 months where rates have dropped back down. Historically, over those 30 years, anytime rates have gone up, they soon follow with a drop.

When working with a lender that offers an ARM product, your payment is NOT static on the day of closing, meaning your ARM payment will change with any adjustments to the Bank of Canada’s overnight policy rate. This means your amortization will remain static and you will pay your mortgage off on time.

When the interest rate drops, your amortization drops. When the interest rate pops, your payment pops.

• When working with a lender that offers a VRM product, your payment will remain static on the day of closing, meaning your VRM payment will not change & only the principal & interest on the back end will fluctuate with any BoC change. This means your amortization will otherwise adjust accordingly.
• When the interest rate drops, your amortization drops. When the interest rate pops, your amortization pops.
• With some static variable rate mortgage products, there is a trigger rate and trigger point which will inflict an increase to your payment should your mortgage ever reach that point (see below for explanation).
• It’s also important to note that not every lender that offers a VRM product, or has the trigger rate / trigger point policy.

• As interest rates on variable rate mortgage products increase, the payments do not change. There will be a point where the principal and interest payments can no longer cover the interest charged on the mortgage.
• This happens when your rate has exceeded the Trigger Rate, otherwise reflecting an INTEREST ONLY payment with additional interest owed if your variable rate increases BEYOND that Trigger Rate.
• Because there is no further principal being paid down, the amortization remains “forever”.
• To offset any payment shock, it’s recommended you increase your monthly payment to cover the outstanding interest given you surpass your Trigger Rate.
• At renewal, the remaining original amortization period, say 25 years after a 5 year term of an original 30 year amortization is used to calculate the new terms payment amount. This is when the ‘reset’ happens on the payment.

• For a conventional VRM product, meaning a mortgage product with 20% or more in equity, the Trigger Point is when the principal mortgaged amount plus interest owing, exceeds 80% of the fair market value of the property as determined by your lender.
• For an Insured VRM product, meaning a mortgage product with less than 20% equity, the Trigger Point is when the principal mortgaged amount plus interest owing, exceeds 105% of the original principal mortgage amount (loan).
• On HELOC products, if at any time the outstanding principal amount (including any deferred interest) exceeds the original principal amount, then your mortgage has reached the Trigger Point.
• What Happens When You Reach Your Trigger Point? Your lender will notify you by letter and inform you of how much the principal amount exceeds the Trigger Point (the excess amount). Once notified, you will have 30 days to either make a lumpsum payment, increase the amount of the principal and interest payment, or convert to a fixed rate term.

• Somewhat! There is an initial approved total mortgage amount, the money is advanced, and there is an agreed upon monthly installment, based on an agreed amortization – a.k.a. ‘the life of the loan’.
• Whereas, a HELOC may have the exact same balance forever with only the monthly interest being paid off. A VRM is initially set up with the idea that it will be paid off in full over 25 to 30 years. Hence the payment including both an interest portion, and a principal portion.
• A VRM seems different than a HELOC, but as you will discover through this series of questions a VRM has some distinct HELOC-like characteristics. For instance, it allows the outstanding balance to move back upwards toward the original approved amount.

• If you currently have a mortgage, your payment will change approximately $12 - $13 for every $100,000 that you owe on your mortgage for every 0.25% change in prime rate.
• If you have a mortgage balance of $500,000 and the Bank of Canada changes their overnight rate by 0.25%, that’s an increase / decrease of about $60 to your monthly payment. Note, a typical increase made by the BoC is 0.25%.
• If your interest rate were to double – that would mean your payment would increase by 25%.
• If your interest rate were to triple – that would mean your payment would increase by 45%.
• A 1.5% increase in annual income is enough to cover a doubling in rates or in other words a 25% increase in your monthly payment 5 years later (income taxes included)
• A 3% increase in annual income is enough to cover a tripling in rates or in other words a 45% increase in your monthly payment 5 years later (income taxes included)