Key Point; STOP misinforming clients re ‘what happens‘ at their trigger rate – because what happens (for the majority of them) is nothing at all. Nada, Zip, Zero, Zilch.
Disclaimer; the content below is reflective of the policies of one lender in particular (the Primary VRM lender in the Broker channel) so take this content as guidance, ask questions, and position yourself as the expert!
If this post were targeted at clients, it would be broken out into multiple posts, at least one post per question, but it’s for you – an expert – and you can handle absorbing all of this at once.
Q1.
Is a Variable Rate Mortgage a bit like a Home Equity Line Of Credit?
A.
Yes, a bit. 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. ‘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 typically. Hence the payment with 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. Such as allowing the outstanding balance to move back upward to the original approved amount.
Q2.
What is a Variable Rate Mortgage?
A.
Generally speaking a VRM is a mortgage with an interest rate linked to Prime, which means the interest rate may change up to eight times per year as per the Bank Of Canada’s Schedule.
Specifically speaking a VRM payment will not change with the rate, which means the amortization will change.
(a.k.a. the ‘life of the loan’)
IE
The interest rate drops, the amortization drops.
The interest rate pops, the amortization pops.
Q3.
What’s an Adjustable Rate Mortgage?
A.
Generally speaking an ARM is a mortgage with an interest rate linked to Prime, which means the interest rate may change up to eight times per year as per the Bank Of Canada’s Schedule.
Specifically speaking an ARM payment will change with the interest rate, which means the amortization will not change.
The ARM client stays on track with a final payout date – no matter what interest rates do, no matter how high their payments go. The goal, the focus, is on maintaining the amortization at all costs… literally.
IE
The interest rate drops, the amortization drops.
The interest rate pops, the payment pops.
Q4.
What’s a Trigger Rate?
A.
You’ve reached the ‘Trigger Rate’ when the interest rate rises to the point that the entire fixed payment is 100% interest.
When a VRM client hits their Trigger Rate (a figure found in their mortgage documents) the effective amortisation, much like a HELOC, is basically… ‘forever’ because no principal is being paid down.
If the interest rate rises past the Trigger Rate then the client will see their mortgage balance shift into reverse and begin to rise each month.
It can continue to rise all the way back to the original contracted balance of day one at which point the term ‘Trigger Point’ matters.
Just a quick note here, when the term of this mortgage segment ends, and the renewal date arrives, the remaining original amortization period, say 25yrs after a 5yr term of an original 30yr amortization is used to calculate the new terms payment amount. This is when the ‘reset’ happens on the payment.
Q5.
What’s the ‘Trigger Point’?
A.
‘Trigger Point’… sounds a lot like Trigger Rate – but it’s not, it’s actually a totally different thing.
First comes the Trigger Rate, the rising rates. Once exceeded eventually there may be a Trigger Point.
The math on triggering a Trigger Point is actually way out there. And I will leave that math for another few rate hikes, because we have not exceeded Trigger Rates yet… yet.
Just know that a conventional mortgage can grow back to 80% LTV of the fair market value of the property. Key words right there – Fair Market Value.
And for this with an insured VRM, the Trigger Point is at 105% of the original principal amount of the mortgage loan.
Think about that.
Built up equity from pay down – cushion #1.
Original down payment of 5%, 10%, or 15% – cushion #2.
This is a long long ways off, will someone hit the Trigger Point before the end of their term?
Will a human land on Mars?
Probably, but not for awhile. Maybe not in our lifetime.
Conclusion
This is the foundational knowledge you need today.
These are the keys to positioning yourself as an expert.
Thank you.
DW