Interest Rate Cap
Definition and meaning of Interest Rate Cap in real estate.
An interest rate cap is a limit on how much the interest rate on an adjustable-rate mortgage can increase during a specific period or over the life of the loan.
In more detail
These caps protect borrowers from extreme payment increases when market interest rates rise. Most adjustable-rate mortgages feature three types of caps: the initial adjustment cap, the periodic adjustment cap, and the lifetime cap. The initial cap limits the first rate change, the periodic cap limits subsequent changes, and the lifetime cap restricts the absolute maximum rate the loan can reach. Borrowers should carefully review these caps to understand the worst-case scenario for their future mortgage payments.
Key facts
| Category | Mortgages & Financing |
|---|---|
| Applies to | Adjustable-rate mortgages |
| Types of caps | Initial, periodic, and lifetime |
| Purpose | Protects borrowers from severe payment increases |
A borrower has an adjustable-rate mortgage with a lifetime cap of six percent above the initial rate, meaning that even if market rates skyrocket, their loan's interest rate can never exceed that limit.
Frequently asked questions
What does a 2/2/6 cap structure mean on an adjustable-rate mortgage?
It means the interest rate can increase by a maximum of two percent at the first adjustment, two percent at each subsequent annual adjustment, and six percent over the life of the loan.
Can an interest rate cap prevent monthly payments from rising?
A cap limits how high the rate can go, but it does not stop payments from rising up to those established limits when interest rates go up.