Owning a home has become one of the best ways to build wealth over time. However, even with the benefits of homeownership, it can still be difficult to navigate a mortgage — especially when interest rates are moving. One of the biggest factors that affects variable-rate mortgages is the Canada Prime Rate.
In this article, we cover how the prime rate can affect your mortgage, how changes may impact your monthly payments, and what your options are.
What Is the Prime Rate in Relation to Mortgages?
According to the Financial Post, a prime rate is a fluctuating number used to set interest rates on several different types of loans, including variable-rate mortgages. As the prime rate moves up or down, so will your interest rate.
If you have a variable-rate mortgage with an interest rate of 3.25%, for instance, and the prime rate goes up, your interest rate will also rise by a corresponding amount. As a result, a greater portion of your monthly payments will go toward interest rather than reducing the principal. Even if your monthly payment stays the same, you'll be paying more in interest charges — which increases the overall cost of your loan over time.
How Does the Prime Rate Affect Mortgages?
Different mortgage types interact differently with the prime rate. A fixed-rate mortgage won't be affected — the interest rate is locked in for the duration of your term. A variable-rate mortgage, on the other hand, has an interest rate tied directly to the prime rate. When prime goes up, so does your rate. When it comes down, so does your rate.
It's important to understand your mortgage type so you can anticipate what will happen to your payment. For example, if you have a variable-rate mortgage and the prime rate has increased but you haven't increased your payment amount, the amortization period of your loan will stretch out — and the total amount of interest you pay will grow as well.
What Is the Trigger Rate?
The term "Trigger Rate" comes into play in a rising-rate environment, where the interest rate for variable-payment mortgages rises without any corresponding increase in monthly mortgage payments. This can result in a higher percentage of each payment going toward interest rather than principal.
The Trigger Rate is the threshold at which the borrower's mortgage payment must increase to cover the additional interest charges — causing a significant change in monthly payment amount. Essentially, it's the point at which your payment is "triggered" to increase because your current payment no longer fully covers the interest.
Solutions
Here are some steps to minimize the impact of changes in the prime rate on your mortgage payment:
- Put extra money on your mortgage. If you have extra funds available, consider putting them toward your mortgage. This reduces the amount of interest you pay and helps you pay off your loan faster.
- Consider refinancing to a fixed rate. If you are concerned about rising rates, switching to a fixed-rate mortgage locks in your payment for the duration of the term.
- Reach out to a mortgage specialist and talk about restructuring. This could involve modifying the loan terms to reduce the interest rate or extending the loan term to lower the monthly payment amount.
- Talk to a financial advisor or mortgage counselor to help assess your financial situation and provide guidance on potential solutions.
Conclusion
The prime rate is not the same as your mortgage interest rate — it's a benchmark that lenders use to set their own rates. But for variable-rate mortgage holders, the connection is direct and immediate. That's why it's important to work with a mortgage specialist who can help you understand your exposure, explore your options, and make the right decision for your situation.
Contact Bonnie today to learn more about how the Canada Prime Rate can impact your mortgage and get guidance on the best path forward.