Bank of Canada raises the Prime Rate by another 0.75%.
The Bank of Canada today increased its target for the overnight rate by another 75bps, or 0.75%. Raising the Prime Rate to 5.45% from its previous 4.7%. The Bank is also continuing its policy of quantitative tightening.
You have likely heard – or will soon be hearing – a lot of talk about “trigger rates” and “trigger points“. If you haven’t yet, then you’ve definitely been hearing about all the recent rate increases that have been happening throughout 2022.
In case you haven’t read our previous blog on trigger rates to familiarize yourself, Let’s start with a few definitions:
- Variable Rate Mortgage (VRM) – As the prime rate changes, so does your contractual rate. When interest rates change, typically, your mortgage payment will stay the same.
- Adjustable Rate Mortgage (ARM) – As the prime rate changes, so does your contractual rate, BUT unlike the variable rate, your mortgage payment will change when interest rates change.
- Trigger Rate – When interest rates increase to the point that regular principal and interest payments no longer cover the interest charged, interest is deferred, and the principal balance (total cost) can increase until it hits the trigger point.
- Trigger Point – When the outstanding principal amount (including any deferred interest) exceeds the original principal amount. The lender will notify the customer and inform them of how much the principal amount exceeds the excess amount (Trigger Point). The client then typically has 30 days to make a lump sum payment; increase the amount of the principal and interest payment; or convert to a fixed rate term.
Who will first be affected by the increases in Prime Rate?
Quick answer, Variable Rate Mortgage (VRM) holders who received their mortgages between March 2020 to March 2022.
During the month of March 2020, the prime rate dropped three times in quick succession from 3.95% to 2.45%, and variable-rate mortgages arranged while prime was 2.45% have the lowest payments. Rates are on the rise now, but they were at some of the lowest points in history during the Pandemic. The lower the interest rate was, the lower the trigger rate, and the faster you may be to hit a negative amortization.
What should I do if I have reached my Trigger Rate?
When this happens, you should be contacted by your lender and generally have three ways that you can proceed:
- Make a lump-sum payment against the loan amount
- Convert with a new loan at a fixed-rate term (Please read our blog on fixed rates if you’re considering locking in your rate)
- Increase their monthly payment amount to pay off their outstanding principal balance within their remaining original amortization period
Example:
Customer A receives a 430k mortgage in January 2020 with a contractual rate of Prime – 0.7%, giving them a net variable rate of 3%. In January 2020, their variable mortgage payments were $2000, where $750 went towards principal and $1250 towards interest. As prime increases, their payments remain $2000/month, but the amount towards principal and interest begins to change.
- In March 2022, the prime rate increases by 0.5% → $500 goes towards principal; $1500 towards interest.
- In April 2022, Prime increases by 0.5% → $250 goes towards principal; $1750 towards interest.
- In June 2022, Prime increases by 0.75% → $0 goes towards principal; $2300 towards interest. Customer A has now reached its Trigger point.
Why has the Bank of Canada continued to raise the Prime Rate?
Global inflation remains high and measures of core inflation are moving up in most countries. In response, central banks around the world continue to tighten monetary policy. Economic activity in the United States has moderated, although the US labour market remains tight. China is facing ongoing challenges from COVID shutdowns. Commodity prices have been volatile: oil, wheat and lumber prices have moderated while natural gas prices have risen.
In Canada, CPI inflation eased in July to 7.6% from 8.1% because of a drop in gasoline prices. However, inflation excluding gasoline increased and data indicate a further broadening of price pressures, particularly in services. The Bank’s core measures of inflation continued to move up, ranging from 5% to 5.5% in July. Surveys suggest that short-term inflation expectations remain high. The longer this continues, the greater the risk that elevated inflation becomes entrenched.
Given the outlook for inflation, the Governing Council still judges that the policy interest rate will need to rise further. Quantitative tightening is complementing increases in the policy rate. As the effects of tighter monetary policy work through the economy, we will be assessing how much higher interest rates need to go to return inflation to target. The Governing Council remains resolute in its commitment to price stability and will continue to take action as required to achieve the 2% inflation target.
Give your Mortgage Professional a Call Today
Understanding all the recent rate increases can be challenging, and finding a solution to your current situation can be difficult to find online as there are many individual factors that will affect your mortgage. If you would like to schedule a consultation, or simply want to give us a call, we are happy to help in any way we can. Even if it’s to provide a little peace of mind during these complicated times.
Contact Darcy Doyle at the Mortgage Professionals today by calling 604-889-7343 or send us an email at darcy@themortgageprofessionals.ca
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