A borrower with a variable rate mortgage experiences a significant rate increase. Their payment remains the same but now only covers interest. What has occurred?

Q: What is the correct answer to: A borrower with a variable rate mortgage experiences a significant rate increase. Their payment remains the same but now only covers interest. What has occurred?

The correct answer is Trigger rate activation. Option B is correct because the trigger rate is precisely defined as the interest rate level where a borrower's payment amount only covers the interest portion of their mortgage, with no principal reduction occurring. When variable rates rise to this threshold, the payment structure shifts from covering both principal and interest to covering interest only. This is a specific mortgage industry term with a precise technical meaning that matches exactly what the question describes.

Q: What background knowledge is needed for this Mortgage & Real Estate Finance question?

Variable rate mortgages have payments that can remain fixed while interest rates fluctuate. The trigger rate is the interest rate threshold where the borrower's payment amount exactly equals the interest charges, leaving no portion for principal reduction. Beyond this point, lenders typically require payment increases or loan restructuring. This concept is crucial under Canadian mortgage regulations, where lenders must disclose trigger rate implications. Provincial legislation requires clear communication of variable rate risks, including trigger rate scenarios, to ensure borrower understanding of potential payment adjustments and amortization impacts.

Q: What is a good way to remember the answer to this Mortgage & Real Estate Finance question?

Think of a trigger rate like a gun's trigger - it's the exact point where something 'fires' or activates. When rates hit the trigger point, your payment 'fires' all its ammunition (money) at interest only, with nothing left for the principal target. When you see questions about payments covering only interest with no principal reduction, immediately think 'trigger point activated' to identify trigger rate scenarios versus other mortgage concepts.

Q: What exam tip applies to this Mortgage & Real Estate Finance question?

Look for key phrases: 'payment remains same' + 'only covers interest' = trigger rate. If payment increases, it's payment shock. If balance grows, it's negative amortization.

Q: How does this Mortgage & Real Estate Finance concept apply in real world practice?

Sarah has a variable rate mortgage with $2,000 monthly payments. When rates were 3%, her payment covered $1,200 interest and $800 principal. After rate increases to 5.5%, her $2,000 payment now covers $2,000 in interest with $0 toward principal. Her lender contacts her explaining the trigger rate has been reached and she needs to increase payments to $2,400 to resume principal reduction, or consider refinancing options.

Question

Mortgage & Real Estate FinanceVariable RatesMEDIUM

A borrower with a variable rate mortgage experiences a significant rate increase. Their payment remains the same but now only covers interest. What has occurred?

Answer Options

A

Payment shock

B

Trigger rate activation

C

Negative amortization

D

Rate cap breach