Neil Joseph
Is the ‘real’ amortization period of your mortgage about to cross 50 years?
There are two kinds of variable rate mortgage products available to Canadians. One is called VRM (Variable rate Mortgage), and the distinguishing feature is that the monthly mortgage payment will NOT change with a change in Prime Rate. The other kind is called ARM (Adjustable-rate Mortgage) and with this one the monthly payment will fluctuate as the Prime Rate changes. Last week, I had analyzed the impact to monthly payments in case of an ARM mortgage and this week I will address the impact to payments in case of a VRM mortgage.
I had initially stated that the monthly payments do NOT change in the case of a VRM mortgage but there is a caveat. It being… The monthly or periodic mortgage payment will NOT increase if the payment is able to cover 100% of the applicable interest costs (doesn’t matter if there is no reduction in principal outstanding!). If the interest rate rises, then the associated interest costs payable in each pay period also increases. Since the payments are fixed and the principal outstanding does not get paid down each month as initially projected, it also results in increased amortization period. Depending on the quantum and speed of this increase in interest rate and the recency of the mortgage, there can be occasions wherein there is a shortfall in the payment to cover such interest costs. Such a level of interest rate is called as the ‘trigger rate’ and it varies for each mortgage depending on various factors.
Given that we are witnessing a steady and significant increase in interest rates and there is a potential for such hikes to continue in the short term (given high inflation), some of the VRM mortgages might be about to hit the rare “trigger rate”.
To identify which mortgages might potentially hit the “trigger rate”, I analyzed the increase in interest costs and amortization period for each increase in Prime Rate that we have witnessed till date (0.25% in March, 0.50% in April and 0.50% in June 2022) and what might potentially take place in coming months. To simulate the future increase in Prime rate, I factored in the latest guideline from Bank of Canada regarding their goal for Policy rate (proposed neutral range of 2 ~ 3% range) and assumed we might see a 0.75%* hike in both in July and September 2022. In the last couple of years banks have generally set their Prime Rate to be about 2.20% higher than the Bank of Canada Policy Interest Rate and so I assumed that the Prime Rate could reach 5.20% or thereabouts.
The below tables show the impact to monthly interest costs coverage and “Real” Amortization period for a $100,000 mortgage secured in Jan 2022 as Prime Rate increases. To depict the monthly interest costs, I considered the interest rate at origination to be 1.65% (Prime Minus 0.80%) as this was sort of the level we saw right before the Prime Rate started increasing from March 2022. But the analysis will hold good even if the interest rate on your mortgage is different.
Month | Interest Rate | Monthly Interest costs | Principal Paid down each month | Amortization period left (years) |
Feb 2022 | 1.65% | $137.03 | $269.72 | 25.00 |
Mar 2022 | 1.90% | $157.28 | $249.47 | 25.85 |
Apr 2022 | 1.90% | $156.89 | $249.86 | 25.77 |
May 2022 | 2.40% | $197.48 | $209.28 | 27.86 |
Jun 2022 | 2.40% | $197.06 | $209.69 | 27.77 |
Jul 2022 | 2.90% | $237.37 | $169.39 | 30.43 |
Aug 2022 | 3.65% | $297.78 | $108.97 | 36.41 |
Sep 2022 | 3.65% | $297.45 | $109.30 | 36.33 |
Oct 2022 | 4.40% | $357.62 | $49.13 | 48.57 |
Table 1: $100,000 mortgage with 25-year Amortization (Monthly Payment fixed at $406.75)
Month | Interest Rate | Monthly Interest Costs | Principal Paid down each month | Amortization Period left (years) |
Feb 2022 | 1.65% | $137.03 | $215.06 | 30.00 |
Mar 2022 | 1.90% | $157.37 | $194.72 | 31.32 |
Apr 2022 | 1.90% | $157.06 | $195.03 | 31.24 |
May 2022 | 2.40% | $197.80 | $154.29 | 34.58 |
Jun 2022 | 2.40% | $197.50 | $154.59 | 34.50 |
Jul 2022 | 2.90% | $238.02 | $114.06 | 39.15 |
Aug 2022 | 3.65% | $298.78 | $53.31 | 52.19 |
Sep 2022 | 3.65% | $298.62 | $53.47 | 52.11 |
Oct 2022 | 4.40% | $359.23 | No Contribution | Infinite |
Table 2: $100,000 mortgage with 30-year Amortization (Monthly Payment fixed at $352.09)
As we can see from the above tables, the amortization period keeps increasing significantly (touching nearly 50 years) in both scenarios and in the case of 30-year amortization mortgage, the monthly payment is NOT sufficient to cover the interest costs after an increase of about 2.75% in interest rate (from origination). In fact, my analysis shows that the 30-year amortization mortgages issued after June 2021 could be at the risk of hitting their “trigger rate” if the interest rate hike scenario as depicted above plays out. Once the amortization period crosses 50 years, a hike in monthly payment is highly imminent. Unfortunately, the online portal that you have access to from the lender might NOT reflect this real amortization period as you are still obligated to repay the mortgage within the original amortization period. Hence, if the “real” amortization period happens to be greater than the original amortization period at the time of renewal, you will see your fixed monthly payments rise to adjust for the mismatch.
Hence, my recommendation would be that you increase your monthly mortgage payment by $20 for every $100,000 mortgage outstanding with each 0.25% increase in Prime Rate. Doing so, will keep help keep the original amortization period intact.