As recent month to month inflation rates for Canada continue to remain above 5%, with some months as high as 8% (in the year of 2022), the Bank of Canada continues to warn Canadians of further interest rate hikes even after the multiple interest rate increases we have experienced this year. The logic is that the increased interest rates encourage people to save more, spend and borrow less which in turn encourages companies to increase their prices at a slower pace or even lower prices to entice people to spend again, resulting in decreased inflation rates. If you are in the process of obtaining a new mortgage, whether you are refinancing or purchasing a property, higher interest rates mean increased monthly mortgage payments and decreased affordability. However, what happens if you have an existing mortgage and the Bank of Canada and prime rates increase?
Existing Fixed Rate Mortgage
The answer is simple if you have a fixed rate mortgage. There is no change in your mortgage payments nor your amortization period as the interest rate of a fixed rate mortgage is locked at the time the mortgage is obtained. So, any changes in the Bank of Canada and Prime Rates have no impact on your existing fixed rate mortgage during the mortgage term.
Existing Variable Rate Mortgage
When it comes to variable rate mortgages, you can either have an adjustable payment variable rate mortgage or a fixed payment variable rate mortgage. Don’t be alarmed if you can’t find “adjustable payment” or “fixed payment” wording in your mortgage agreement as these are not universal terms that all the banks use to describe the different types of variable rate mortgages.
Adjustable Payment Variable Rate Mortgage
If you have an adjustable payment variable rate mortgage, your monthly mortgage payments will increase when the interest rate increases and your monthly mortgage payments will decrease when the interest rate decreases in order to maintain the same amortization period that you signed up for.
Fixed Payment Variable Rate Mortgage
If you have a fixed payment variable rate mortgage and the Prime Rate changes, your monthly mortgage payment amount will remain the same, however, the amount of the monthly mortgage payment that goes towards paying the interest and principal will change. This ultimately results in a change in the amortization period. If the prime rate inreases, the portion of the monthly mortgage payment which goes towards the interest will increase and the portion which goes towards paying down the principal balance of the mortgage will decrease, resulting in an increased amortization period.
Be Mindful of your Trigger Rate
There is another layer that you need to consider if you have a fixed payment variable rate mortgage. Canadian mortgages in general are designed to ensure that homeowners are always building equity. In order to ensure such, if interest rate hikes result in the monthly mortgage payment amount of your fixed payment variable rate mortgage to be less than the interest payable, the monthly mortgage payment amount will increase by the minimum sufficient amount that is required to cover the interest payable. The interest or trigger rate that will warrant an increase to your monthly mortgage payment depends on the mortgage amount, monthly payment amount and interest rate.
Every lender uses a different formula to calculate the trigger rate but you may use this general one for quick reference:
(Payment amount X number of payments per year / balance owing) X 100 = Trigger Rate in Percent
To obtain a more accurate trigger rate, review your mortgage documents and ask your mortgage lender.
If you require legal advice or representation with your real estate property purchase or refinancing, or have questions about residential or commercial real estate law in general, contact us at Sukh Law.
Sukh Law publishes articles for information purposes only and is not intended to constitute legal advice.
